A new consensus is quietly forming around Canada’s telecommunications industry – a painful narrative that is putting more pressure on the sector’s sinking share prices. After years of easy wins, cable and wireless companies are trapped in a new era of tepid growth, and there are no easy fixes in sight.
Historically, Canada’s Big Three telecom companies – BCE Inc. BCE-T, Rogers Communications Inc. RCI-B-T and Telus Corp. T-T – were magnets for dividend lovers because they paid sizeable yields. But their shares started sliding around March, 2022 because central banks starting raising interest rates and telco yields suddenly looked much less attractive. In some cases, their yields are now lower than those offered by an ultrasafe guaranteed investment certificates, or GICs.
For a while, there wasn’t much reason to panic. Scores of stocks that are sensitive to interest rate changes were also sliding, such as those for real estate investment trusts, or REITs. But lately, the bottom has started falling out for telecom companies, and until very recently, it wasn’t clear why.
Over the past three months, the Big Three telco stocks are down an average of 16.1 per cent, while the S&P/TSX Composite Index is up 4.3 per cent. During this rout, BCE has been the worst hit, down 20 per cent. BCE’s stock has fallen so far, so fast, that its dividend yield is now 8.9 per cent annually, a level that was once nearly unthinkable for such a large company with strong margins in a protected industry.
Telecom giants start reporting their next batch of quarterly earnings this week and solid results could help to re-instill some investor confidence, but the expectation is that BCE, Rogers and Telus are in for a long slog. All three are grappling with strong headwinds: Much lower immigration, fierce wireless competition and the continuing destruction of the traditional cable television business.
Put together, growth will be incredibly challenging.
“While we continue to wait for eventual rate cuts, wireless pricing and related competitive dynamics will need to get more rational to help Canadian telecom stocks resuscitate,” wrote Adam Shine, a National Bank Financial analyst, in a note to clients on Friday.
Layered on top are heavy debt burdens, particularly at Rogers, which added billions of dollars to pay for its $26-billion acquisition of Shaw Communications Inc. The deal closed in April, 2023, and Rogers has successfully started paying the debt down, but its total burden still amounts to roughly five times its earnings before interest, taxes, depreciation and amortization, or EBITDA.
BCE and Telus are in less danger, but their debts still amount to around 3.5 times their respective EBITDA. Within the industry, 2.5 times EBITDA is considered ideal.
For the past few years, Canadian telcos could comfortably rely on immigration to drive growth, which helped mask debt concerns. In 2023, the Canadian population increased by nearly 1.3 million people, largely driven by a rise in temporary foreign workers. Yet in March, Ottawa changed course and dramatically slashed its temporary resident levels.
The policy reversal had an outsized impact on the telco sector. In Canada, almost everyone who plans on getting a cell phone has one by now, and the same goes for people looking for high-speed internet in major cities, so growth comes from newcomers.
At the same time, the industry now has heavy competition, particularly for cell phone plans.
Within the wireless segment, Freedom Mobile was the only company that could truly challenge the Big Three, but it was owned by Shaw and got shackled by Ottawa’s two-year review of the Rogers-Shaw takeover. The deal closed one year ago, and since then Freedom, which was ultimately sold to Quebecor as part of the acquisition, has been trying to win customers with aggressive pricing.
Such competition was expected last fall, as the telcos typically launch deals around back to school in late August, and again around Black Friday. But the discounted pricing continued into 2024, and the extent of it was not fully appreciated by investors.
March is known as conference season within the telecom industry, a time when executives speak publicly about their businesses, and this year leaders revealed they were all still offering deals, which spooked some investors.
“Competitive intensity levels on both wireless and Internet are currently higher than initially anticipated with all operators participating in some capacity,” wrote Drew McReynolds, an RBC Dominion Securities analyst, in a note to clients in early April.
And then there is the continuing cord cutting that has plagued the sector for years. Cable television used to be a very lucrative business model because telcos offered bundles that more or less forced customers to pay for channels they didn’t watch. But lately, this business has been ripped apart with more intensity, as streaming captures additional market share.
Bell used to make its name as the premium cable company with the most-watched shows on channels such as CTV, so it feels the pain from this trend. Rogers, meanwhile, used to be somewhat insulated, because it was big on wireless, but it just bought a cable company in Shaw.
As all these forces were coming into focus, BCE announcing another round of restructuring in February, this time eliminating 9 per cent of its work force, and also resetting its growth expectations. BCE now expects its free cash flow to drop between 3 per cent and 11 per cent this year.
Compounding the pain, some analysts have discovered that BCE used some unique accounting methods to adjust for certain cash flows. Once these were factored in, the amount BCE paid out each year in dividends can account for as much as 180 per cent of its cash flow.
One possible solution for the Big Three is to expand beyond Canada’s borders so that they aren’t so beholden to the economic and population dynamics here. But that doesn’t look likely.
They’ve dabbled outside of Canada before, and it’s often ended badly. BCE bought long-distance carrier Teleglobe Inc. in 2000, which had major U.S. operations. But Teleglobe filed for creditor protection in 2002 after the dot-com bust, and BCE wrote down billions of dollars. Cogeco Communications, a smaller rival to the Big Three, also ran into trouble with expansions in Portugal and the U.S.
Of the Big Three, Telus is arguably doing the most to diversify, with a call centre and IT services business known as Telus International, as well as health and agriculture units in Canada. But Telus International shares have struggled since their 2021 initial public offering, and the other divisions have barely moved the needle.
The sector’s saving grace is that it still has huge profit margins, often around 35 per cent to 45 per cent. But growth is an open question, and that’s what investors are most focused on at this point.
“With this not-exactly rip roaring start to 2024, in the absence of stabilization in competitive intensity, we expect 2024 guidance to come under increased scrutiny as the year progresses raising the question of whether there are any true winners in this environment,” Mr. McReynolds of RBC wrote in his recent note to clients.
Tim Kiladze