Quebecor Inc. - Little Known Telecom Growth Play

Summary

• Double digit annual growth in mobile subscribers due to lower penetration levels in Quebec.
• Large cash pile to sustain growth capex and share repurchases.
• Prospects of increase in cash dividend as the management attains its long term financial leverage targets.

Company Description

Quebecor Inc. (OTCPK:QBCRF) is a Quebec-based telecom company offering wireless telecommunication, cable and television services in Quebec. In terms of scale, it has a 16% market share in wireless telephony in its coverage area (Quebec and some parts of Ontario). Its subsidiary, Videotron is the largest cable operator in Quebec and the third largest in Canada. It also offers conventional and specialty television through its subsidiary, TVA Group.

Source: Company financial statements

Investment Thesis

Strong subscriber growth prospects

The company has enjoyed double-digit annual growth of 20.5%pa in mobile subscribers in the past five years due to lower wireless penetration levels in Quebec.

Lower penetration levels in its primary market bode well for the growth prospectus of the company. According to Canadian Radio-television and Telecommunications Commission (CRTC) data for 2016, the province of Quebec had a wireless penetration level of 73.5% compared to Canadian national average of 84.3%. Similarly, Average revenue per user (ARPU) in Quebec was lower at $55.36/month compared to national average of $64.91/month.

Smart phone ownership at 70% in Quebec was also reportedly lower than national average of 77%.

These indicators make Quebec a market with higher growth potential than the Canadian national average. The company is likely to focus its energies on its home market, Quebec, as evident from its recent sale of non-core spectrum licenses in other provinces. The company has capitalized on this potential by strengthening its service offering through LTE technology, Apple devices and data packages.

Large cash pile to sustain growth capex and share repurchases

The company has an enviable balance sheet flexibility to fund its growth plans. Its CAD2billion growth dry powder comprises of a cash pile of CAD865 million and additional borrowing capacity. The cash has accumulated after sale of spectrum licenses to Shaw and Rogers during 2017. The company can use this spending capacity to:

• Repurchase shares including the remaining 18.47% minority interest held by Quebec pension fund, Caisse de dépôt et placement du Québec (if it is willing to sell)
• Invest in IPTV (Internet protocol television) by licensing Comcast Corporation’s XFINITY X1 platform
• Invest in 5G technology

Prospects of a cash dividend increase

The dividend yield of the company at 0.6% is substantially lower than its peers (median 4.2%) as some years ago the management decided to reduce dividend payout to manage its high financial leverage. Now that the company has reduced its financial leverage and established its credibility in the financial markets, it can enhance its cash dividend payout. The management has not made any concrete statement in this regard, however, it seems to be getting comfortable that the long term financial leverage targets have been attained and cash dividend increase remains one of the options.

Note: Quebecor payout for 2017 is unusually low due to the large gains booked on sale of spectrum licenses. Its payout was 53% in 2016 and 70% in 2015.

Financial Projections

Our back of the envelope cash flow forecast for the company is presented below:

Source: Estimates

The forecast is based on the following assumptions:

• We have estimated the sales levels based on maintaining the growth trends in subscribers and ARPU for mobile telephony, internet access and cable.
• We are assuming that EBITDA margin trends of Telecom, Media and Sports & Entertainment segments will be maintained around last two years average level.
• We use an effective tax rate of 32% (average of last two years)
• We are forecasting capex of 17% of revenues which mainly comprises project/maintenance capex only. We are not factoring in any inorganic (M&A) capex.
• We think working capital needs will be in line with last five years average.

Discounted Peer Multiples Valuation

Compared to its peer group, the company trades at a 16% discounted valuation (EV/EBITDA).

We find this an attractive proposition given the low mobile penetration in Quebec which will ensure subscriber and ARPU growth for the company.

DCF Valuation

We assign a target price of CAD33.7/share to the TSX listed QBRb.TO shares and USD25.7/share for the NASDAQ OTC traded QBCRF based on a Discounted Cash Flow (DCF) valuation implying an upside of 37%. The DCF has been carried out with a terminal growth rate of 3% and WACC of 7.4%. We have used a cost of equity of 11.0% which includes a risk premium for less liquid small cap stock.

Source: Estimates

Our WACC of 7.4% comprises of the following elements:

Cost of equity of 11.0% is built up from:

• Risk-free rate of 2.11% from the latest yield on 10-year government of Canada benchmark bonds
• Equity market risk premium of 5.08% for Canada from Professor Aswath Damodaran's website
• Leveraged beta of 0.9 based on the average unleveraged beta of peer group adjusted for leverage
• Small cap risk premium of 4.33% based on risk adjusted excess returns earned by small cap stocks compared to the market from 1926 to 2014
• Cost of debt of 3.9% based on historical 2017 cost of debt adjusted for tax.
• We have calculated weight of equity based on market capitalization and for debt based on book value.
• Our terminal value is based on a normalized year and we use a modest terminal growth rate of 3%.

Conclusion

We see an upside potential in the stock due to expectations of above average subscriber growth in Quebec. The company has the financial muscle to capitalize on this opportunity. Any increase in cash dividend payout will be an icing on the cake.

Disclaimer: This report is a personal opinion only and should not be considered as an "investment advice" or as a "recommendation" regarding a course of action. Only registered investment advisers can provide personalized investment advice. Investors should get personal advice from their investment adviser and should make independent investigations before acting on any information published here.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.