Canadian Telcos As The New Utilities

Includes: BCE, RCI, TU
by: Baskin Financial Blog

By Barry Schwartz

As I left my house this morning, I made sure to remember to put three things in my jacket, cellphone, keys and wallet. As I walked to the subway station, I checked the weather conditions on my blackberry, then I checked the stock futures (that was a mistake) and then I checked my email. As I got on the subway, I put in my earphones to listen to some Bob Dylan and looked around the train. People were either doing one of three things, sleeping, reading a book or checking something on their smartphone. You get the picture. We can’t live without our phones and I can imagine one day our phone will also act as our house key and our wallet.

Telcos are the new utilities. The three major telcos in Canada, Bell Canada (NYSE:BCE), Telus (NYSE:TU) and Rogers Communications (NYSE:RCI), sell us products and services that we cannot live without. When our contracts run out, there is always a better phone with better features to entice us to sign up again for three years, at a higher price. Sure there are upstarts with cheaper offers, but they don’t have the best phone brands or reliable networks. According to research performed by comScore, Inc., smartphone penetration in Canada reached 40% as of September 2011. In a couple of years penetration could be as high as 75%. If you are in the market for a new phone, you might as well have internet, email and data access. This will be a huge win for the telcos as more of their customers will be spending $30-50 a month extra for the data.

In this environment, where investors are looking for predictable earnings and a steady stream of income, telcos should continue to outperform. In fact, one could argue that the telcos deserve to trade at a premium to the utility group. Why should Enbridge (NYSE:ENB), Fortis (FRTSF.PK) and TransCanada (NYSE:TRP) trade at close to 20 times earnings vs. the telcos which are at 12-14 times, when the telcos have lower capital expenditure requirements, better balance sheets and higher dividend growth potential? With many of the utilities already paying out close to 70% of earnings, there is little room for dividend growth. Rogers, on the other hand, has a dividend payout of less than 50%. This means lots of room for future dividend increases.

We own all three of the Canadian telcos for our clients, but our favourite name in the space is Rogers Communications. Rogers’ stock has underperformed the group over the past couple of years, even though it has increased its dividend 52% since 2004. Rogers is trading at less than 12 times 2012 expected earnings and offers a current yield of 3.8%. We expect a 10% dividend increase in February 2012 and again in February 2013.

Disclosure: The author and/or family members own shares in Rogers Communications, Bell Canada, and Fortis. Clients of Baskin Financial own shares in, Rogers Communications, Bell Canada, Fortis and TransCanada.