When the equity strategists at BMO Nesbitt Burns hit the road in December to share their 2015 outlook with clients, they were hit with deep skepticism of one of their calls in particular: Buy Canadian telecom stocks.
Yes, BMO notes, there is an "overhanging regulatory threat" at BCE Inc., Telus Inc. and Rogers Communications Inc., with the Harper government continuing to find a way to introduce more competition into Canada's wireless sector.
And yes, part of investors' concern may be valuation: BCE and Telus had banner 2014s, with both up roughly 20 per cent, including dividends. (Rogers, which lagged the two in performance and is restructuring, posted a small decline last year.) All three are trading at higher earnings multiples than at any time since the financial crisis, and are priced higher than their U.S. counterparts.
Bay Street, on the whole, embraces the concerns, with analysts mixed, at best, on the three big telcos. According to Bloomberg data, 10 of 24 analysts rate Telus stock a "buy." For BCE, it's just 7 of 24, and just 6 of 24 for Rogers.
But, says Brian Belski, BMO's chief investment strategist, there's a "clear improvement" in earnings growth in the sector, and the regulatory threat is actually "receding."
And because not enough investors believe either of those arguments, he says, most Canadians are underweighting the sector in their portfolios.
"We are upgrading telecom to outperform based on a clear trough in actual earnings growth and expectations, as the threat of new entrants has diminished and pricing power has been restored," Mr. Belski says in his early-December report. (As chief investment strategist, his role is different from BMO's sell-side analysts who cover the specific companies.)
Mr. Belski may be part of a minority, but he is not alone. Kevin Toomey of Citigroup Global Markets Inc. initiated coverage on the stocks in November, calling the Canadian telecom industry "a better place to be" for American investors than with U.S. names such as Verizon Communications and AT&T.
"We believe the Canadian market for large-cap Telecom offers better prospects for growth and shareholder returns than the U.S. market," he says.
While Mr. Toomey notes the risks of continuing government attempts to promote competition, he says Canada has "a better industry structure" than the United States, i.e. an "oligopoly" with a "rational pricing environment."
He also cites lower mobile-device penetration; extensive holdings of wireless spectrum by the carriers; less pressure on traditional "wireline" businesses and favourable demographics (a wealthier, growing population). "There is still room for upside as these Canadian stocks deserve a premium valuation to the broader average of telco and cable stocks that Citi covers."
Telus is Mr. Toomey's top pick, as he expects growth in wireless and profit-margin improvements in the company's wireline business to help Telus beat analysts' expectations this year and next. He also expects "significant future returns of capital to shareholders" from growing dividends and stock-buyback programs. His target price is $49, versus Friday's close of $41.51 .
He also has what he calls an "out of consensus" buy on BCE, with a target price of $60 (versus Friday's close of $54.35), because he expects improving wireless performance and synergies from BCE's recent acquisitions to help it beat expectations this year or next.
He – and others positive on the sector – is coolest on Rogers Communications because of its slower growth rates, elevated debt that should impede stock buyback and dividend growth, and his expectation for "speed bumps" following its recent restructuring.
Tim Casey, the telecom/media/cable analyst for BMO, also says he expects Rogers' results to be "volatile" after the company missed third-quarter earnings expectations and said 2014 profit would come in at the low end of their guidance range.
"Rogers is in the very early days of a multiyear, enterprise-wide transformation, and we expect some volatility in quarterly results over the next year and a half," he says. "We believe investors will have to remain patient for the turn in Rogers' operating and financial metrics."
(The biggest bull on Rogers is Desjardins Capital Markets' Maher Yaghi, whose recently raised target price of $48.50 is the highest of all Rogers analysts. He says Rogers' lack of share appreciation makes it "a more attractive investment opportunity based on valuation.")
Mr. Belski's sector call is based in part on his pessimism on another major Canadian sector, energy. He said BMO clients are "consumed with picking the bottom" in the space, but BMO's strategists believe there will be an "extended period of stagnant earnings." Many clients believe energy stocks have fully priced in the current price of oil, he says, and "although this may be mostly true for now, we believe investors are underestimating the potential depth and duration of the current energy price pullback."
The telecoms, then, offer "a natural substitute out of the dividend growth names in the energy sector," Mr. Belski says.
BMO's Mr. Casey, in his separate report, sees a 10-per-cent increase in Telus' dividend and 5 per cent at both BCE and Rogers. The three are all currently yielding between 3.9 per cent and 4.6 per cent.
Citi's Mr. Toomey says he believes investors "underestimate BCE's ability to increase its shareholder returns over time," through share repurchases and dividend growth that could top the consensus expectation of 5 per cent.
At Telus, he says, the dividend is at the low end of the company's targeted payout range. The company's commitment to growing it while also repurchasing shares results in a "repatriation yield" – a combination of the two – that comes in at 6 per cent in 2015 and should grow to 8 per cent "over the next few years," per Mr. Toomey's forecasts.
Maybe all of that can overcome some investors' skepticism.
Globe app users click here for a chart of Canada's top telecoms.
David Milstead