Rising interest rates are sending tremors through the stock and bond markets this year, but Canadian telecommunications stocks have been holding up well.
If the volatility persists, they are likely to remain go-to bets among rattled investors.
BCE Inc. BCE-T, Telus Corp. T-T and Rogers Communications Inc. RCI-A-T are up by an average of nearly 7 per cent this year, while the S&P/TSX Composite Index is down more than 2 per cent over the same period.
In some ways, this may look perplexing. At a time when central banks are raising their key interest rates aggressively in an attempt to control surging inflation, stocks known for their dividends should look less enticing.
This week, the U.S. Federal Reserve raised its key rate by half of a percentage point, marking its biggest hike since the end of the dot-com euphoria more than two decades ago. The Bank of Canada made the same move last month.
As interest rates rise, yields on fixed-income investments also gain, luring money away from the stock market. Why stick your neck out for a stock when you can now score a sure 3.8 per cent on some five-year Canadian guaranteed income certificates?
Even stocks with big dividends can be susceptible to rate hikes, especially so-called bond proxies – shares of heavily regulated and slow-growing companies that resemble bonds.
A 5 per cent dividend yield might look like a no-brainer when bond yields are ultra-low. This week, though, the yield on the 10-year U.S. Treasury bond popped above 3 per cent for the first time since 2018, and up from just 1.2 per cent last summer.
But Canadian telecom stocks – often viewed as bond proxies – are still in positive territory this year, even though they are down from recent highs. Rogers, a standout, is up 13 per cent at a time when banks, real estate firms, industrials, consumer discretionary companies and tech stocks are under water.
There are a few reasons for this relatively strong performance.
Businesses that provide internet and cellphone connections look like safe bets at a time when observers are growing concerned that rising rates will push the economy into recession. The U.S. economy contracted by 1.4 per cent, at an annualized pace, in the first quarter.
The relative safety of bond proxies may be overriding concerns that dividend yields look less appealing as interest rates rise.
“We are in a risk-off market, when you tend to go to things that are more defensive,” Laura Lau, chief investment officer at Toronto-based Brompton Funds, said in an interview.
BCE’s first-quarter financial results, released on Thursday, underscored its solid foundation.
Profit – in terms of adjusted EBITDA, or earnings before interest, taxes, depreciation and amortization – increased by a steady 6.4 per cent over the same quarter last year. The company expects profit will rise between 2 per cent and 5 per cent over 2022, again underscoring the steady nature of the business.
Telecom stocks come with additional attractive features, though.
In Canada, these stocks make up a relatively slim weighting within the broader market, especially next to giant sectors such as financials and energy producers.
There are only a handful of Canadian telecom players, so when investors take an interest in the sector, a lot of money is funnelled into a narrow space, which can support share prices.
What’s more, Rogers is working toward finalizing its takeover of Shaw Communications Inc., which was approved by the telecom regulator in March.
“It’s a consolidating industry. When that happens, returns tend to get better because there is less competition,” Ms. Lau said.
Where are these bond proxies headed next?
If market volatility settles down, they may struggle as investors pounce on beaten-up stocks in other sectors, such as technology. Amazon.com Inc. is down 30 per cent this year and Google-parent Alphabet Inc. is down 19 per cent.
Telecom stocks are also facing threats that include shrinking old-style wireline revenues and uncertainty over business customers who need fewer lines in a post-pandemic world.
Jérome Dubreuil, an analyst at Desjardins Capital Markets, on Friday raised his price target for BCE – or where he expects the shares will trade within 12 months – to $70 from $68 previously. But he maintained a lukewarm “hold” rating on the stock.
“While we believe BCE will remain a core holding for many funds, we believe it is too early to put an overweight tag on the stock,” Mr. Dubreuil said in a note.
Still, with a dividend yield of 5.3 per cent and bulletproof operations, it’s an attractive stock to own in a world of uncertainty.
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David Berman