BCE's Strong Performance Not Dependent on Income Trust Conversion

Shares of BCE (BCE), Canada's largest telecom provider, soared about +15% on news that the company planned to convert to a high-yielding income trust. But following the Canadian government's legislative bombshell, the shares have returned to their previous trading range.

If the government's draft legislation is not enacted and management goes ahead with the conversion, then BCE will yield about 10% based on planned annual cash distributions of $2.55 per trust unit. If the conversion doesn't go ahead, then the stock will still pay a healthy 4.8% dividend, based on a $1.17 annual payout per unit over the past year. Either way, the stock is worth a second look.

BCE is the equivalent of say, AT&T (T) without the crowded playing field. BCE dominates the fixed-line phone service in eastern Canada, is the second-largest wireless carrier in the country after Rogers Communications and is the number one satellite TV provider in Canada. To ward off potential competition from wireless and cable, BCE is rapidly converting its fixed phone lines to high-speed Internet protocol and has joined forces with wireless provider Virgin Mobile. So far, it has been able to get 60% of its existing customers in the eastern provinces to bundle two or more services.

In addition to its diverse array of telecom services, BCE owns content, including 20% of CTV, Canada's leading private broadcaster.

Over the past three years, the company has been refocusing on its core communications business by selling unrelated operations. As a result, earnings are expected to grow about +10% next year and about +7% annually over the next five years. With management expecting free cash flow of between $700 million and $900 million (Canadian) this year, the firm's dividend should be secure.

As a foreign-based company, BCE's dividend is subject to a 15% foreign withholding tax. If the shares are held in a taxable brokerage account, then you can claim a foreign tax credit on IRS Form 1116. If they are held in a tax-exempt IRA-type account, then the tax deduction is not so easy to obtain. The stock is also subject to changing currency exchange rates between the value of the U.S. and Canadian dollar.

With a P/E of about 13 times next year's estimated earnings, the shares are trading on a par with AT&T. However, given BCE's higher dividend yield, the shares warrant a higher multiple. The price is right, but investors should note that volatility in the Canadian/U.S. exchange rate does add some risk to this security. BCE is suitable only for medium-risk investors.

Disclosure: Author has no position in BCE

BCE 1-yr chart: