Cogeco Communications Remains Undervalued

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About: Cogeco Communications Inc (CGEAF), Includes: BCE, CABO, CCA, CHTR, QBCRF, RCI, SJR
by: Ploutos Investing

Summary

Cogeco Communications lost nearly three thousand high-speed Internet customers in Canada in its fiscal Q4 2018.

Its Internet subscribers decline was primarily due to its transition to a new customer management system.

Cogeco pays a growing dividend with a dividend yield of 2.9%.

Investment Thesis

Cogeco Communications (OTCPK:CGEAF) (TSX:(CCA)) posted mixed Q4 2018 results. While the company added nearly 47 hundred cable Internet subscribers in the United States, it lost about 30 hundred Internet subscribers in Canada. The subscribers loss in Canada was mainly due to its transition to a new customer management system. The company’s current share price is undervalued when compared against its peers. Cogeco has consistently increased its dividend in the past. The company remains a good choice for investors seeking both capital gain and dividend growth.

Cogeco

Source: YCharts

Recent Developments

Cogeco posted mixed results in its Q4 2018 earnings. While the company continues to add more high-speed Internet subscribers south of the border (more will be discussed later in the article), its Canadian high-speed Internet subscribers declined by 2,965 subscribers to 782,277 subscribers (see chart and table below). As a result, its Canadian cable revenue declined by 1.6% to C$319.5 million. Its Canadian Cable EBITDA also declined by 3.2% to about C$164.0 million.

Cogeco

Canadian broadband internet subscribers (Source: Created by author; Company Reports)

2018

2017

Q1

9,565

14,766

Q2

6,880

9,877

Q3

693

5,198

Q4

-2,965

5,519

Fiscal Year Total

14,173

35,360

Canadian Internet net additions (Source: Created by author; Company Reports)

Implementation of a new customer management system appears to be the reason behind its weak quarter

It appears that the decline in Internet subscribers was due to Cogeco’s implementation of a new customer management system. Back in Q3 2018, management expressed that they were replacing its 22 legacy systems with a new customer management system. The new system should provide better customer experience and improve the organization’s overall efficiency. However, the transition may take more time and as a result of the transition, some marketing activities have been scaled back or postponed. Management in the latest conference call stated that this transition might continue to weigh on its results in Q1 2019. Although the transition will weigh on its revenue in the short term, its new system should eventually result in an improvement in its EBITDA margin.

Cogeco’s U.S. cable Internet business continues to perform well

Unlike intensified competition in Canada, Cogeco’s U.S. Internet business continues to perform well. The company added 4,693 Internet subscribers. As can be seen from the chart below, the company has consistently increased its Internet subscribers sequentially (the spike between Q1 2018 and Q2 2018 was due to its MetroCast acquisition). Compared to its competitors, Cogeco holds a competitive advantage, as it is able to offer Internet speeds of 200Mbps in most of the footprint and 1Gbps service in over 50% of the footprint. On the other hand, most of its competitors are still using legacy DSL networks (about 85% of the footprint that its competitors operate except Florida is still using legacy DSL network).

Cogeco

Source: Created by author; Company Reports

Attractive Valuation

Cogeco currently trades at a forward EV to EBITDA ratio of 6.33x. This valuation is much lower than its peers. As can be seen from the chart below, its valuation is below its Canadian peers Shaw Communications’ (SJR) 7.28x and Quebecor’s (OTCPK:QBCRF) 7.73x. Cogeco’s forward EV to EBITDA ratio of 6.33x is also below its U.S. peers. For example, Charter Communications (CHTR) and Cable ONE (CABO) are trading at multiples of 9.65x and 12.18x respectively.

Source: YCharts

Cogeco currently pays a quarterly dividend of C$0.475 per share. This is equivalent to a forward dividend yield of 2.9%. The company has consistently increased its dividend in the past. In fact, it has increased its dividend by a compound annual growth rate of 12% since 2014.

Source: YCharts

Risks and Challenges

Cable TV continues to face structural headwind

Like many other cable companies, Cogeco’s legacy cable TV business continues to face structural headwind as consumers gradually switch to other platforms such as IPTV. If Cogeco cannot resume growth in its Internet subscribers, its top and bottom lines will be impacted negatively.

Source: Created by author; Company Reports

High debt to EBTIDA ratio

Cogeco’s net debt to EBITDA ratio has risen to 3.4x following the acquisition of MetroCast. This ratio is quite high especially when we compare it with its Canadian peers. Companies such as BCE (BCE), and Rogers Communications (RCI) have net debt to EBITDA ratios of 2.7x and 2.5x respectively. Nevertheless, we think Cogeco can gradually reduce its debt ratio with its free cash flow generated, as its dividend payout ratio is quite low.

Source: Q4 2018 Financial Presentation

Competition will likely increase in Canada

In Cogeco’s main areas of operation in Canada (Quebec and Ontario), competition is expected to increase, as its main competitor BCE gradually upgrades its DSL network to FTTH (fiber-to-the-home).

Investor Takeaway

Cogeco Communications’ declining cable Internet subscribers in Canada was due to its implementation of a new customer management system. Although it might take another quarter for this transition to be completed, the company should regain growth momentum in its cable Internet service in Canada. We believe its share price is undervalued based on our comparative analysis. Given its good track record of dividend growth, we believe dividend growth investors with a long-term investment horizon will be rewarded.

Note: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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Disclosure: I am/we are long RCI, SJR.

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.

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