Investors have fallen in love with telecom stocks this year, but with the sector hitting new highs in recent months, it's a wise time to reassess the romance.
The lure has been large dividend payouts, strong and stable businesses and the booming popularity of smart phones. But the stock prices of Canadian telecoms have done so well this year that they have met or exceeded analysts' targets, while the companies' overall performances have remained relatively steady and competition has increased.
The question for investors now is whether they should sell and take their profits, or hold on for the dividends and hope that share prices are supported by even more yield-seekers buying in.
Rogers , the nation's largest cable operator and wireless carrier, sent a wakeup call to the market on Tuesday, posting disappointing results that it blamed on a "new competitive reality" as well as rising costs. The stock tumbled off its 52-week high, falling 8 per cent in heavy trading. Last Friday, shares of Shaw fell 6 per cent after the Calgary-based company missed quarterly expectations and warned of stiffer competition.
The new landscape includes a handful of upstart wireless firms, such as Wind Mobile and Mobilicity, that are building traction with consumers through discounted pricing, simplified agreements and aggressive marketing campaigns.
Rogers, Telus Corp. and BCE Inc.'s Bell Canada initially dismissed the new services as poor alternatives to their own national networks. But the upstarts have forced the incumbents to be more aggressive with their own discount brands, a move that cuts into their profits. Additionally, Shaw and Quebecor Inc.'s Vidéotron Ltée are in the process of launching wireless networks.
BCE and Telus take centre stage next Thursday and Friday, respectively. Both stocks are close to 52-week highs and both fell in sympathy with Rogers on Tuesday. Telus lost 4 per cent of its value and BCE dropped more than 1 per cent.
"Canadian telco stocks are amongst the most expensive in the world," Dvai Ghose, an analyst with Canaccord Genuity, said in a recent report. "We reiterate our fear that we may be seeing a bubble develop in Canadian telecom stocks that has been driven by an indiscriminate thirst for yield."
Rogers, BCE and Telus are growing in the low single digits, yet they are trading at relatively high price-to-earnings multiples. BCE trades for 12.5 times current earnings, while both Rogers and Telus change hands for 14 times earnings.
Jonathan Allen, an analyst with RBC Dominion Securities Inc., agrees that the current level of valuation is hard to justify based on the fundamentals of the companies themselves, especially in the new competitive environment. But he notes that there is more at play in these valuations than the corporate performances alone.
"This divergence between stock valuation and underlying fundamentals has been driven by a global, top-down investor appetite for dividend yield - a trend that may well continue for the foreseeable future against a backdrop of modest global economic growth and modest corporate earnings," he writes.
"Normally, we would be reluctant to chase share prices with higher target valuation multiples, but in this case we believe the appreciating global [comparables]and sustained investor appetite for dividend yield justifies higher valuations for the Canadian telecom sector."
For investors who pick stocks based solely on the underlying performance of the company, it is probably time to cash in telecom profits. But for those who are willing to take a broader view, the sector should remain appealing as long as interest rates don't start inching upwards. If yield is the deciding factor, then investors will likely have to stomach more volatility like Tuesday's and stay alert for any signs that heightened competition is eating into telecoms' cash flow.
Some of the sector's alluring yields (annualized):
BCE: 5.2 per cent
Rogers Communications: 3.1 per cent
Telus: 4.2 per cent
Shaw Communications: 4.0 per cent
Bell Aliant: 10.3 per cent
MTS: 5.7 per cent
Source: Globe Investor