It has not been a good year for Canada's telecommunications sector. As of the close of trading on Friday, the S&P/TSX Capped Telecom Services Index was ahead only 2.3% for the year - barely above break-even. That placed it in the unenviable position of being the worst performing sector on the Toronto Stock Exchange.
What's happened? It's not as if our telecom companies are going broke - in fact, in broad terms they're performing reasonably well. Part of the problem is that investors don't see a lot of upside potential in the shares right now. Much of the blame for that can be laid at the doorstep of the Conservative government in Ottawa. Its quixotic attempts to encourage the creation of a fourth major wireless provider in Canada have so far achieved nothing more than to raise a cloud of uncertainty over one of our most important industries.
The government's latest maneuver is the plan to auction off more wireless spectrum on terms that are supposed to encourage a potential competitor to step forward. More than half of the 50 megahertz of AWS-3 wireless spectrum, which will be sold in early 2015, is being allocated to small companies. (AWS stands for advanced wireless spectrum.) Previous auctions were dominated by the Big Three of Rogers, BCE, and Telus, which control 95% of the wireless market in Canada. Moreover, regulations will make it difficult for a smaller company to resell any spectrum it purchases to one of the Big Three at a later date.
Growth in the wireless sector is seen as the key to future profit gains for the telecoms, with traditional cable and wireline revenues under pressure as more customers cut the cord. If Ottawa somehow succeeds in its efforts to create a viable fourth player, investors and analysts believe the inevitable result will be to draw business away from the Big Three. Without strong wireless growth, they'll stagnate.
Even without a fourth player, the Big Three are coming under pressure in the wireless sector, with Rogers Communications (TSX: RCI.B) (NYSE: RCI) hurting the most. The company's second-quarter results showed that operating revenue from wireless was down 1% year-over-year. Net postpaid wireless additions (the most-watched statistic) were down 60% for the quarter and 90% for the first six months of fiscal 2014. The company blamed a previous government policy, the outlawing of three-year contracts, for the dramatic slowdown in growth.
The weak wireless performance contributed to a drop of 13% in the company's second-quarter profits. Year-to-date, net earnings at Rogers are off 15% from 2013.
All of these factors contributed to our advice to sell Rogers shares last month. But what about the other two large telecoms, BCE and Telus?
Both companies reported second-quarter results earlier this month and in both cases we saw the same phenomenon - a slowdown in wireless growth. However, the results weren't as dramatic as in the case of Rogers.
BCE results
BCE (TSX: BCE)(NYSE: BCE) reported a 5.5% increase in wireless operating revenue for the quarter to just over $1.5 billion. Postpaid net additions totaled 66,186 compared to 96,390 last year, down 31%. Like Rogers, the company blamed the drop to "slower overall market growth resulting from the elimination of lower-priced 3-year contracts as mandated by the new federal Wireless Code of Conduct".
Overall, the company's second-quarter results, released on Aug. 7, continue to show strength. BCE reporting operating revenue of $4.22 billion, up 4.4% from the same period in 2013. Net earnings attributable to common shareholders were $606 million ($0.78 per share), an improvement of 6.1% from $571 million ($0.74 per share) a year ago.
I have a friend who runs down BCE stock every time we discuss the market. It's a badly managed company, he insists, and its media operations are highly vulnerable to a downturn in advertising.
I agree about his comments relating to advertising and in fact Bell Media is in the process of severing 120 employees due to softness in the TV ad market. Despite this, Bell Media posted a revenue increase of 36.1% to $761 million for the quarter, due mainly to last year's acquisition of Astral Communications.
As for bad management, it seems to me the company has done very well for investors since the bid to take it private collapsed in December 2008, shortly before I recommended the stock. We have more than doubled our money and we're receiving a dividend yield of 11.6% based on the original recommended price. I doubt many readers are unhappy with that. Based on the current price, the stock yields 5.1%.
Of course, as we always say in the investment business, past results are no guarantee of future returns. But I see BCE as a solid, multi-faceted business. It's not going to crash and burn any time soon. The decision to purchase the balance of the shares in Bell Aliant that it didn't already own and to privatize the company will add further to BCE's revenue and profitability in the years to come.
As a result, I am maintaining my Buy recommendation on the stock, which closed on Friday at C$48.29, US$44.33. The share price has pulled back from its 52-week high, which was reached in early June, and represents fair value at this level.
Telus reports financials
Telus (TSX:T, Financial)(NYSE:TU, Financial) also had a good second quarter. Operating revenue was up 4.4% to just under $3 billion, meeting analysts' expectations. Adjusted net income, which strips out unusual costs and revenue, rose 9.3% to $387 million ($0.63 per share). On an earnings per share basis, that was a 16.7% improvement over the same period in 2013. Free cash flow was up 9.4% to $210 million.
Wireless network revenues increased by $85 million (6.1%) to $1.5 billion in the quarter. The growth was driven by continued subscriber base expansion, higher data usage as a result of a continued increase in smartphone adoption, the expansion of the company's LTE network coverage, and increased data roaming.
However, like the other two majors, new wireless activations were down. Telus reported net additions of 58,000, compared to 79,000 a year ago, a decline of 27%. The total wireless subscriber base was up by 170,000 from a year ago to 7.9 million, a 2.2% increase. Higher-value postpaid subscribers represent 87% of the total subscriber base.
Telus CEO Darren Entwistle didn't comment directly on Ottawa's policies in his remarks accompanying the financial results. But he reminded investors and, by extension, federal politicians of the huge investments the Big Three have made in creating a national telecom network.
"The Canadian telecommunications industry represents an intensely competitive and rapidly changing market where carriers are required to meet the evolving demands of our customers in respect of service excellence," he said.
"Despite being challenged with a vast and tremendously diverse geographic landscape and dispersed population, our high quality networks have become the envy of the world owing to the fact that they have been built in a regulatory environment that requires meaningful facilities based investment. Telus alone has committed $111 billion in technology and operations since 2000 to bridge the digital divide by providing best-in-class technology and wireless coverage to 99% of the Canadian population."
The message may have been veiled but it was clear - we've spent billions setting up the network. Allowing a new competitor to piggyback on it now would be patently unfair.
Despite everything, Telus is doing well enough to reward with a dividend increase of 11.8% to $0.38 per quarter ($1.52 annually), effective with the Oct. 1 payment. This boosts the forward yield on the shares to 3.95% based on Friday's closing price. That's well below the yield for BCE, suggesting that investors see Telus as having more growth potential.
Telus also continues to actively buy back shares through its normal course issuer bid. As of July 31, the company had purchased 10.7 million shares thus far in 2014 at an average price of $38.34 for a total cost of $410 million.
The stock continues to be a Buy for income and modest growth. The shares closed on Friday at C$38.48, US$35.32.
The bottom line is that I expect both Telus and BCE to provide decent but not spectacular returns over the next year. If Ottawa finally decides to quietly abandon its seemingly futile efforts to create a fourth major wireless player that could boost the shares of all of the Big Three telecoms. But don't hold your breath. Stephen Harper is one stubborn dude.
