Canadian telecom stocks have delivered lucrative gains over the last year, sweetened with some of the biggest dividend payouts in the market. But with many economists and market watchers now warning about renewed inflationary pressures, the sector is about to lose some of its appeal.
During periods of inflation, companies that can pass on higher costs to customers do best. Professional investors, in particular, look for stocks that have pricing power -not those being squeezed by competition to lower prices.
Canada's incumbent phone companies lack that pricing power. They are cutting their wireless rates as new players such as Wind Mobile, Mobilicity and Public Mobile offer cheap unlimited talk-and-text plans and discounted data rates. On Tuesday, Telus Corp. launched an unlimited talk-and-text plan in Alberta and British Columbia, following similar moves nationally by BCE Inc. and Rogers Communications Inc.
Telus's move is likely to further depress wireless rates in Canada, noted UBS Securities Inc. analyst Phillip Huang. And while Telus called the latest pricing plans a limited market trial, its website hinted that cheap data plans might follow.
The "golden age" of pricing came between 2002 and 2008, when Bell, Telus and Rogers could charge wireless customers whatever they wanted. But that period is over, says Dvai Ghose, an analyst with Canaccord Genuity Corp. Telecom is today in a period of deflation , he says.
In contrast, the latest consumer price index report showed a 2.2-per-cent annualized increase for February. Prices are rising even faster for a broad range of products, including food, energy, insurance and housing. Gasoline prices, for example, rose almost 16 per cent over the month.
Yield Vs. Growth
The big Canadian cable and telecom players have attracted investors in this ultra-low interest rate period with dividend yields in the range of 4 per cent to 6 per cent. But as the economic cycle shifts and rates start to rise, investors need to rethink whether they want to favour yield over growth.
Investors who "rushed to buy these types of companies for their dividends should reconsider how much they [want to]have in their portfolio," says Barry Schwartz, vice-president and portfolio manager at Baskin Financial Services Inc. in Toronto.
He says his firm is "paring back" on Canadian telecoms and may look to sell positions in the future. Baskin Financial used to buy the shares of BCE, Telus and Rogers for its clients' portfolios, but for the last six months it has lightened up on the sector by purchasing only Rogers shares for new client portfolios, Mr. Schwartz said.
To try to counter falling prices for wireless and landline services, cable and telecom companies have been trying to differentiate their offerings by acquiring exclusive content. Bell Canada has just completed its purchase of CTVglobemedia Inc., Shaw Communications Inc. purchased Canwest and Rogers bought CITY-TV. In addition, Quebecor Inc. owns TVA Group.
But the strategy is adding significant risk for each of the companies, Moody's Investors Service warned in a recent report. The recent purchases have "increased their cash-flow volatility" and carry potential downside implications over the mid-to-longer term.
"The economics of the TV business have been quite challenging over the recent past, and there are no natural synergies between TV and broadband," wrote the authors, Bill Wolfe, vice-president of senior credit, and Donald Carter, managing director of corporate finance.
No Rush to Sell
But even though it looks like cable and telecom stocks are heading into tougher times, money managers aren't rushing to sell their positions.
"Inflation is coming," agrees Adrian Mastracci, portfolio manager with KCM Wealth Management Inc. in Vancouver. Still, he's not advising his clients to dump their telecom stocks.
"I wouldn't be too unhappy about holding telecoms," he says. It's not just that an investor faces transaction fees and capital gains taxes with a sale, but it's very hard to consistently make the right sell calls over a long period.
For investors staying the course in telecom, selecting the right stocks is key. Mr. Ghose is maintaining his "buy" rating on Telus and price target of $56. He rates both BCE and Rogers as "hold." Among the factors he says favour the Vancouver-based company is that the new wireless players are largely focused on Ontario. He also rates Quebecor and Cogeco Cable Inc. as buys.
Looking out 18 months, Mr. Ghose thinks the pricing dynamics for Canada's telecom sector could change quickly with consolidation occurring among the newest competitors. That would reduce competition and pricing pressure and could boost profitability.