Canadian telecom stocks are supposed to be rock-solid investments. Buy the shares, collect the big dividends and watch your riches grow.
But uncertainty is now challenging the sector as new consumer-friendly smartphone plans are threatening telecom profits. How should investors approach this new era?
Rogers Communications Inc. underscored the sector’s challenges last week when it announced its third-quarter financial results: Profits missed analysts’ expectations and Rogers reduced its full-year revenue and earnings guidance.
The share price fell 8.1 per cent on Oct. 23, marking its worst one-day performance in more than six years. The slump dragged down rivals BCE Inc. (which reports its third-quarter results on Thursday morning) and Telus Corp. (which reports on Nov. 8).
Although telecom stocks have been regaining some lost ground over the past several days, the S&P/TSX Composite communication services sector is down nearly 4 per cent since Oct. 22.
“Investors are nervous and questioning if the telecom space is fundamentally broken,” Maher Yaghi, an analyst at Desjardins Securities, said in a note last week.
Here’s another approach: New smartphone plans that offer unlimited data are causing a few financial bumps right now but should deliver benefits for the telecom sector down the road.
Canada’s big three national telecom companies are diversified beyond wireless services, of course. There’s television service, traditional landlines and, in the case of Rogers, even the Toronto Blue Jays baseball franchise.
But wireless is arguably the biggest attraction for investors. Wireless service drives more than 60 per cent of Rogers’s annual revenues and 57 per cent of Telus’s annual revenues (in 2018, according to Bloomberg). The number of subscribers continues to rise, driven by Canada’s strong immigration trends and low unemployment levels.
The rate of Canadian smartphone ownership – the penetration rate – is also rising. According to the Canadian Radio-television and Telecommunications Commission, 78 per cent of adult Canadians owned a smartphone in 2017, up from 73 per cent in 2015. The rate should continue to rise given that most smartphone ownership studies show Canada lagging the U.S. penetration rate and much of the developed world.
The latest quarterly results from Rogers, though, showed that there is one wrinkle in this bullish backdrop: Telecom companies have relied on charging consumers hefty overage fees when they breached their data limits, but new unlimited-data plans mean that these fees – which totalled $1.7-billion industry-wide in 2017 – are set to drop.
In the case of Rogers, which has been more aggressive than its rivals in marketing unlimited data, overage fees in the third quarter (the first to reflect the new plans) fell by $50-million. The issue will continue to weigh on financial results amid a consumer shift. While overage fees account for about 5 per cent of Rogers’s wireless service revenue, the fees are set to decline to about 1 per cent within the next 12 months.
So why should investors embrace this uncertainty? There are at least two offsets at work here.
First, the new plans should translate into fewer irate consumers speed-dialling customer-care centres to complain about overage fees, which means service costs to telecom companies should decline over time. Already, Rogers is saying that billing and data overage-related calls have fallen 50 per cent.
Second, clear bills that don’t contain month-end data surprises should drive up smartphone adoption rates in Canada, clearing the way for higher penetration rates that will help underpin wireless growth.
These two offsets could take some time to kick in, of course. In the case of Rogers, Mr. Yaghi says that the fourth quarter could be another rough one, in terms of year-over-year comparisons.
But Rogers’s shares trade at just 14.4-times trailing earnings, which is close to their lower price-to-earnings ratio over the past five years and down from an average of 17.6 – implying that a lot of impatience is built into the current share price. BCE and Telus shares are more expensive, but offer dividend yields of 5.2 per cent and 4.9 per cent, respectively. The recent turbulence simply makes these stocks more attractive.