Large telecommunication companies are offering an attractive dividend yield with promising future outlooks. However, the competition is heating up, because in Canada, there are several new entrants whereas in the U.S. existing players are expanding their market share.
I will discuss two larg telecommunication companies Verizon Communication, Inc. (NYSE:VZ) and BCE, Inc. (NYSE:BCE) which are operating in the U.S. and Canada respectively. I will use a discounted free cash flow model in order to determine whether the price of both the companies is overvalued, undervalued or fairly valued. In my previous article, I have determined the price for VZ, which comes out to be $52.74 per share. However, using the same assumptions I will now determine the price of BCE.
To determine the share price, 30% weight will be assigned to debt and 70% weight to equity. Cost of equity and after-tax cost of debt is 9.15% and 3.15, respectively, so the required rate will be 7.45%. Moreover, terminal year growth rate is assumed to be 1.0%.
U.S. $ Million
Expected Free Cash flows
PV of Cash Flows
Total value of firm= $61733.2 million
Total Debt= $16330 million
Total value of equity= $45403.2 million
Public market discount=15%
Public market value= $36322.56 million
Both the stocks are undervalued and we can expect the rise in the prices but VZ has an edge because according to the above analysis it expects a price appreciation of 8.78% if we compare it with the current price. On the other hand, BCE expects a rise of only 4.87%.
Source: Yahoo Finance
As shown in the table above, BCE is comfortably placed in terms of both operating and profit margins. BCE has more dollars (before tax and interest) than VZ for each dollar of sales. Similarly, even after adjusting for other expenses BCE is well placed. It clearly shows that BCE has been able to manage its cost more effectively and is more profitable. The Canadian macro environment is relatively healthier than in the U.S. and any additional spending by the consumers is directly linked with their economic well being.
The table below shows that both the companies sustain attractive dividend yield in a current low-yield environment but BCE preserves its advantage as its dividend yield is higher than that of VZ. The payout ratio didn't show much because VZ has been reporting EPS, which is less than dividends per share. Moreover, there are graphs below that show the earnings surprise for each quarter over the last two years for both companies. In all quarters except for 4Q'11 BCE did beat analysts' estimates; VZ was not able to meet the expectations in several quarters. So, it clearly shows that BCE has been more consistent and it managed to deliver as it was expected.
Source: Yahoo Finance
(click to enlarge)Some key ratios for evaluating mature companies paint an encouraging outlook for VZ. Both P/S and Net debt to adjusted EBITDA is lower for VZ, which is an encouraging sign. Moreover, VZ also has a high five-year growth rate coupled with a favorable figure for PEG, which gives VZ an edge over BCE.
Net debt to Adjusted EBITDA
PEG (5 Year Expected)
Next 5 years Growth Rate/annum
Source: Yahoo Finance
BCE has an edge because of high dividend yield, favorable profit margins and consistency in terms of earnings. Whereas, VZ clearly has been better in terms of key ratios and earnings growth rate. I believe that both companies possess a great potential but VZ will win the battle because of high expected future growth rate. Moreover, VZ is well equipped because of its top class network quality with one of the lowest churn rates and large subscriber base. It also has the largest footprint of 4G LTE technologies covering around 89% of the U.S. population. VZ is much more equipped to capitalize the movement of video to wireless as it is moving into a new cloud and connectivity services. As discussed earlier, both companies are undervalued and expect a rise in the share prices but VZ is looking at a price appreciation of 8.78%, which is way more than that of BCE. So, on a total return basis VZ has a clear advantage. On the other hand, BCE is currently well placed but its future growth estimates are not very encouraging with a modest growth rate.