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Summary

  • Company’s fundamentals remain solid due to attractive wireless trends.
  • Dividend set to remain highly stable over long term with safer credit outlook and strong FCF backing.
  • Investors should wait for pullback before buying stock since it's currently overvalued.

BCE Inc. (NYSE:BCE) is among the leading telecom companies in Canada. The company recently reported a mixed financial performance for 1Q14. The company's wireless segment continued to grow in recent quarters; the service revenue growth of the segment was driven by the continuous improvement in ARPU. Moreover, the migration of customers to smartphones drove EBITDA growth for the recent quarter. However, the wireline segment's revenue base remained pressurized due to secular changes, but Fibe TV net additions and a controlled cost approach positively affected the quarter's results. Moreover, with strong FCF generation and a relatively stronger balance sheet than its peers, the investor-friendly dividend side of the company is completely secure. I recommend long-term, growth-seeking investors to wait for a pullback in the stock before initiating a "buy" position, as currently the stock is expensive based on my price target of $41.

Wireless Segment Success Story in Continuation

The attractive Canadian wireless industry structure and a rational pricing environment continue to help BCE sustain its long-term wireless segment growth. The company's strong wireless operation, which witnessed 4.4% year-on-year service revenue growth in 1Q14, was driven by the continual improvement in ARPU. Increased smartphone usage and high rate plan pricing driven by the transition to two-year contracts were among the many ARPU drivers in the quarter. Moreover, the ARPU and revenue growths drove the company's EBITDA margin, which was up 2.4% year-on-year in the recent quarter. However, I believe given that smartphone penetration is about to mature, the company needs to look to other growth prospects to ensure long term success of the wireless segment's top-line results.

The recent quarter's wireless segment growth with smartphone penetration and pricing initiatives makes me believe in strong top-line growth of BCE's wireless segment in coming quarters. The following table shows the growth in the wireless segment's ARPU, service revenue and EBITDA margin.

1Q-13

2Q-13

3Q-13

4Q-13

1Q-14

Service Revenue

(Y-O-Y growth)

6.6%

5.6%

4.1%

3.5%

4.4%

ARPU

(Y-O-Y growth)

3.5%

2.4%

1.7%

1.5%

3.4%

EBITDA Margin

44.9%

45.9%

45%

38.9%

46%

Source: Company's Quarterly Earnings Report

The recent quarter's wireless segment postpaid net adds was subdued due to the shift of customers from three to two-year contracts. As a matter of fact, in the recent quarter, key wireless segment players equally experienced a low net additions trend for postpaid subscribers. However, I believe BCE is well positioned amongst its peers to grow its subscriber base in the future due to its strategic initiatives. The following chart shows postpaid net adds of BCE.

Source: Company's Quarterly Earnings Report

Secular Changes Continue to Pressurize Wireline Segment…

The company's wireline segment results in the recent quarter were strongly affected by secular changes in the industry, namely the growth of wireless operations. However, as the company keeps on expanding Fibe TV to Ontario, BCE's subscriber momentum keeps on growing. Furthermore, Fibe TV's subscriber base, along with 55,000 additions in the recent quarter, continued to pull through the high speed internet net additions with 16,000 net additions in this quarter.

Wireline revenue declined YoY by 2% due to a sluggish business environment and seasonal changes. However, despite the revenue pressures, EBITDA margins remained relatively stable at 37.8%, as operating costs declined by 1% YoY in the recent quarter. I believe that going forward the FTTx and IPTV rollouts under BCE's Fibe TV offering could drive subscriber momentum. However, the OPEX related to the rollout may keep the near-term margins checkered. The following table shows growth in BCE's revenue.

1Q-13

2Q-13

3Q-13

4Q-13

1Q-14

Revenue

(Y-O-Y growth)

(2.8%)

(0.9%)

(0.9%)

(0.3%)

(1.8%)

Source: Company's Quarterly Earnings Report

The following chart shows moderating net additions trend for Fibe TV and HSD of the wireline segment.

Source: Company's Quarterly Earnings Report

Secure Dividend Base = Strong Balance Sheet + Strong FCF base

BCE remains an attractive stock for dividend investors. The company's dividends are completely secure in the long run, with a strong cash flow base and relatively stronger balance sheet than its peers. Moreover, the company's FCF base in the current quarter, up 5.7% YoY, strongly supports BCE's 5.40% dividend yield, well ahead of Rogers Communications' (NYSE:RCI) dividend yield of 4.42% and TELUS' (NYSE:TU) 4.07%. The following chart shows YoY growth of BCE's FCF base.

Source: Company's Quarterly Presentation

Moreover, the company stands with a relatively safer balance sheet than RCI, with its debt to equity of 1.4x. Furthermore, I believe the company's strong FCF generation projects will portend well to grow BCE's balance sheet. I believe the safer credit profile of BCE will keep the company's dividend base growing. The following table shows the comparison of debt to equity and interest coverage ratio of BCE with its peers.

Debt To Equity

Interest Coverage

BCE

1.4x

4x

TU

0.9x

5.1x

RCI

2.8x

4.1x

Source: Morning Star

Conclusion

I maintain my "hold" thesis on BCE. I believe the company's fundamentals remain solid, primarily driven by attractive wireless trends. However, secular wireline pressures are key risks to the struggling wireline segment results. I believe that dividend will remain highly stable over the long term with a safer credit outlook and strong FCF backing. Moreover, I expect strong growth in all fundamentals of the company with the rollout of Fibe TV offerings in coming quarters. Based on my price target of $41, the stock is currently overvalued, therefore, I recommend investors to wait for a pullback before initiating a "buy" position in the stock.

Source: Now Not The Time To Buy BCE As Stock Currently Overvalued