3 Reasons Canadian Telecom Stocks Are Undervalued - And What to Buy Now

Ruth Saldanha: Hello and welcome to our limited time series, the Morningstar Canada Stocks Outlook for 2024, where we will speak with Morningstar Equity analysts to find out what they expect in the new year. Today Matthew Dolgin of Morningstar Research Services is here to discuss Canadian telecom stocks, almost all of which are very undervalued. Matthew, thank you so much for being here today.

Matthew Dolgin: Thanks Ruth.Thanks for having me.

Why Are Canadian Telecom Stocks Undervalued?

Saldanha: So we are starting this year with the telecom stocks being undervalued. Why is that?

Dolgin: Well, I'd say there were three big things working against these companies in 2023. The first one, and the one that has nothing to do with these businesses, is higher interest rates. So, as interest rates went much higher and stayed high, these stocks sold off a lot. And when we saw a couple months ago, interest rates kind of bottoming for now, they turned. And so I think they'll continue to be sensitive to interest rates, and that was a headwind. From a more fundamental perspective, there was a regulatory threat hanging over the telcos, which are BCE (BCE) and TELUS (T), the ones that we cover. And then we also had Quebecor's (QBR.A) entrance as a national competitor in the wireless space, starting in April after they acquired Freedom Mobile. And so that just brings a new level of competition to the big three in wireless, that they didn't have before, as well as some regulatory pricing rates that they'll have to compete against.

What Will Happen to Canadian Telecom Stocks in 2024?

Saldanha: So going ahead into 2024, what can investors expect from these stocks?

Dolgin: Well, as I said, we've made actually a sizable move off the bottom. Each of the four companies we cover has made a double-digit percentage move since they bottomed. And I would expect that to continue. You mentioned that we see them each as undervalued, and so I'd expect the gap to close. But I do think they will remain sensitive to interest rates. So if rates head back up, or also if they're going to stay higher, that's going to be pressure that will probably prolong how long it will take to get back to our fair value estimates. On the flip side, if rates were to stay at these little bit lower levels, head down more, and if it becomes clear that rates have peaked for this cycle, that should provide a boost. And then apart from that, we'll see how these other risks play out, and assuming that the fear was maybe worse than they actually are in reality, they should be things that allow these companies to close that gap with our fair value estimates.

Watch Out for Regulatory Risk in Canadian Telecom

Saldanha: You mentioned in 2023 one of the drivers for these stocks was the regulatory risks. Is that still a concern next year? And what are some of the risks that you're watching?

Dolgin: Yeah, the regulatory risk is, so the initial decision the CRTC put out last month, it really was limited only to BCE essentially requiring it to wholesale its fiber network to other competitors who might want to sell services on its network. We're going to see that decision evolve because like I said that was the initial one so we'll see if it brings in other territories or other companies again notably TELUS in a requirement to wholesale its fiber network. So that regulatory decision isn't completely played out and we'll also see how it works when it actually is implemented. BCE was required to allow access to its network within six months which means the first half of the year we'll see if competitors come in and how that might affect BCE. Apart from that again I mentioned Quebecor it is new to the space, it's got some momentum we did not see that so far in 2023 really affect the big three certainly as far as their ability to add new subscribers but as Quebecor gets its footing more, enhances its network more we'll see if that fourth competitor really is a bigger threat to the big three.

Bell and Telus May Grow Dividends, Rogers and Quebecor May Not

Saldanha: One of the things I wanted to discuss today was dividends. Now these companies are usually pretty robust dividend providers. What's the outlook for 2024?

Dolgin: Well I expect BCE and TELUS to be able to continue to grow their dividends. Their capital spending on their fiber networks is down off of the peaks and should stay down so they really should have the ability to raise the dividends further if they choose. I expect that TELUS will. Bell I probably expect that they do also, the yields are because the stock prices are so low very high right now but I still think they've got the ability to increase and certainly the dividends are very safe. As far as Rogers (RCI.A) and Quebecor (QBR.A) I wouldn't necessarily expect dividend growth because they have other priorities. Rogers took on a lot of debt to acquire Shaw and so its priority will be paying that down I'd say before it looks to raise the dividend. At Quebecor it does need to invest in its own infrastructure in that wireless footprint that it now has outside of Quebec. So I wouldn't say it's the priority for those companies but again their dividends are good right now and I'd say they are safe.

Morningstar’s Top Canadian Telecom Stock Picks

Saldanha: Finally what's your top Canadian telecom pick for 2024?

Dolgin: I'd say Rogers right now is still the one that I like most. I think it has a couple of things going for it that its competitors don't have. For one thing after that Shaw acquisition it still has a lot of room to cut some of the redundant costs. So I would expect its margins to go up more than, well certainly more than competitors but I think there's a lot of room for margin expansions. Also Rogers has had the most success in adding new wireless subscribers so I think it really has the best I'd say marketing infrastructure in place to reach those that are new to Canada which has really been driving the new subscriber additions in the wireless industry in Canada and so I'd expect Rogers to be able to continue taking advantage of it than others and so that's why I think it stands out a little bit versus its peers.

Saldanha: Okay, thank you so much for joining us today Matthew. From Morningstar I'm Ruth Saldanha.