BCE Inc. was banking on its attempted purchase of Astral Media Inc. to goose its cash flows and fund dividend increases. It even went ahead and hiked its quarterly dividend nearly 5 per cent in August, to 56.75 cents a share, when it looked like the deal would go ahead. With that plan now dashed, investors should be mindful that BCE's status as a born-again dividend hiker could be at risk.
For a decade in the late 1990s and early 2000s, BCE investors could only watch in frustration as management passed up dividend increases to instead invest in a string of high-priced failures such as Teleglobe. The board rediscovered its shareholders under former CEO Michael Sabia and successor George Cope. The dividend is now 89 per cent higher than where it was in late 2004.
But to keep increasing dividends, BCE – which reports third-quarter earnings on Thursday – needs to keep boosting its earnings and free cash flow. Its current target is to pay out 69 per cent of free cash flow to investors this year. While the company has said it's on track to increase free cash flows by 7.3 per cent this year, investors should look closely at where that growth is coming from and ask what's next – especially now that the deal for cash-rich Astral has been blocked.
Neeraj Monga, an analyst with Veritas Investment Research, cautions that much of that free cash flow growth in 2012 is coming from one-time items, including a reduction in severance payments and adjustments in working capital. Without Astral, Mr. Monga forecasts BCE's cash flow in 2013 will be the same level as in 2012, or $2.43-billion. That could make it "harder and harder" for BCE to keep raising dividends, Mr. Monga says.
Should investors despair? Not yet. While BCE is starting to hit limits to growth by acquisition in Canada, it still has a couple of options. It could buy the portion of regional operator Bell Aliant Inc. that it doesn't own. It could also dust off calculations on a potential merger with Telus Corp.'s wireline business, a move that would come at the cost of throwing open the protected Canadian telecom market to full-fledged foreign competition, should the government consent. Both deals would come with big operating savings.
In the absence of either deal, potential shareholders have to focus on how much juice is left in BCE's growth businesses (wireless, Internet-based TV and data services), and whether it's enough to more than offset the declines from the high-margin wireline business in the years ahead. Investors should not assume that BCE's steady dividend increases will continue.
Sean Silcoff