Shaw Communications: Multiple Years Of Growth Expected

Summary

• Shaw Communications is a leading cable operator in Western Canada and currently the fourth largest wireless communication service provider in the country.
• Shaw should be able to grow its wireless segment with strong subscribers and ARPU growth in the next few years.
• The company is suitable for investors with a long-term investment horizon.

Investment Thesis

Shaw Communications (SJR) (TSX:SJR.B) had a good Q1 F2019 in both its wireline and wireless segments. The company should continue to benefit from strong growth in its wireless segment as it continues to deploy its 700MHz spectrum and expand its coverage areas to other parts of Canada. We also expect it to buy more spectrums in the upcoming spectrum auction, thanks to favorable government policy towards new entrants. In its wireline Internet business, the implementation of DOCSIS3.1 should help Shaw to compete against TELUS (TU). In fact, after several quarters of negative subscribers growth, the company saw its wireline Internet subscribers growth rate turn positive in the past quarter. We expect Shaw to grow its EBITDA at low double digits in the next few years. Hence, it is a good holding for investors with a long-term investment horizon.

SJR.B data by YCharts

Recent Developments

Shaw delivered excellent Q1 F2019 earnings with strong top and bottom lines growth. As can be seen from the table below, its revenue increased by 8.8% year over year to C$1.355 billion. Its operating margin expanded by 1.6 percentage points to 40.2%. Its net income also increased significantly to C$187 million.

Source: Q1 2019 Financial Report

Strong growth in wireless segment

The increase in its revenue was primarily driven by strong growth in its wireless segment. As can be seen from the chart below, its wireless segment revenue increased by nearly 60% to C$273 million in Q1 F2019 from C$171 million in Q1 F2018.

Source: Q1 2019 Financial Report

In Q1 F2018, Shaw added about 86 thousand postpaid wireless customers. This was much better than the postpaid subscriber adds of 33 thousand in Q1 F2018.

Source: Created by author; Company Reports

Including its prepaid customers, the company now has over 1.46 million wireless subscribers. This is an increase of nearly 287 thousand subscribers from a year ago. As can be seen from the chart below, its year-over-year growth rate has accelerated from 10% growth rate in Q4 F2017 to 24.3% in Q1 F2019.

Source: Created by author; Company Reports

Shaw's blended average revenue per user also increased to C$41.99 per month in Q1 F2019. This was a growth rate of 11.9% year over year. Like its total wireless subscribers growth rate, its ARPU growth rate has also accelerated from the low of 0.7% in Q4 2017 to 11.9% in Q1 F2018.

Source: Created by author; Company Reports

Stabilized Wireline Internet

One of the main reasons why Shaw's share price underperformed in the second half of 2018 was due to its wireline Internet business. The company's wireline Internet subscribers declined by 3,754 and 3,481 in Q3 F2018 and Q4 F2018, respectively. However, this part of the business has rebounded nicely in Q1 F2019 and added 5,606 subscribers. The deployment of DOCSIS 3.1 was a big factor in the past quarter as Shaw can now offer gigabit speeds across all of its cable footprint. This will help Shaw to defend its market share and compete against TELUS's FTTH deployment.

The return of growth in its wireline Internet business is important because, like other cable companies, Shaw also continues to experience cord-cutting to its legacy cable TV business. In the past, Shaw has relied on an increase in rates as well as wireline Internet subscribers to offset decline in cable TV subscribers in its wireline segment. As a result of positive Internet subscribers growth, revenue in Shaw's wireline segment increased slightly to C$1.083 billion in Q1 F2019 from C$1.075 in Q1 F2018.

We think there are multiple years of growth ahead

The stabilization of Shaw's wireline segment is important because what lies ahead for Shaw is multiple years of growth in its wireless business. Here, we will share why we think Shaw will experience significant growth in its wireless business.

Positive churn rate

For the first time since Shaw acquired Freedom mobile and entered the wireless market in 2016, Shaw released its wireless churn rate. The churn rate of 1.28% in Q1 F2019 was very good especially compared to the churn rate of 1.64% a year ago. The low churn rate of 1.28% in Q1 F2019 is even better than BCE (BCE) and Rogers' (NYSE:RCI) churn rates of 1.3% and 1.48%, respectively (based on 2017 report), but higher than TELUS's 0.99%.

We think the improvement was due to its much improved network quality in the past few years and its relatively lower monthly rates than the major incumbents. Management warned that there might be some quarter-over-quarter volatility due to the higher composition of its bring your own device plans, but the result should stay around 1.28% level for the entire fiscal 2019. A comparable churn rate to its peers is important, as Shaw will have more cushions to grow its ARPU without worrying too much about its customers switching to other providers.

700 MHz spectrum deployments

In Q1 F2019, Shaw continued to deploy its 700 MHz spectrum, and the deployment is about 25% complete. Management expects to complete most of its 700MHz deployment by the end of its fiscal year. When asked in the conference call whether 80% deployment is possible, management responded that the number would be a little high. We think the deployment of this low band spectrum will help provide customers with much better coverage and stronger indoor reception. It should help keep its customers satisfied and maintain its churn rate.

Bidding of 600MHz spectrum in 2019

The upcoming auction of 600MHz spectrum in March 2019 will help Shaw to gain much needed spectrum to improve its quality and performance of its wireless network. The federal government is setting aside 30 MHz of spectrum (or 43% of total bandwidth) towards new entrants that have less than 10% of the national wireless subscriber market share. Shaw's wireless market share of about 4.5% (#4 in market share) is still well-below the 10% threshold. This means that Shaw do not have to compete with the larger incumbents for the spectrum and the company will likely pay much less to acquire the needed spectrum compare to TELUS, Rogers, and BCE.

Possibility of bundling with its other services

Although this may not happen in 2019, we think Shaw will eventually start bundling its wireline services (Internet, video, etc.) with its wireless services. Bundling will help Shaw to fend off its competitors, retain its customers, and protect its margin. Perhaps, Shaw's peer Quebecor (OTCPK:QBCRF) can help investors get a better idea about the impact of the bundling. Since Quebecor started bundling its services, the company has realized that the churn rate for customers opting for four services remains more than 10 times lower than for customers opting for single service. Because of this low churn rate, its net total ARPU has increased at a 10% compound annual growth rate since 2004. Its ARPU has also reached C$153.28 in Q2 2017 from C$46.5 in 2004. Based on Shaw's recent wireless ARPU growth performance, we have good confidence that Shaw will imitate Quebec's ARPU growth trajectory.

Quebecor's Net Total ARPU (Source: Investor Presentation)

Cross-selling opportunities

There are tremendous opportunities for Shaw to grow its business through cross selling. For reader's information, Shaw uses the brand "Shaw" for its wireline services and uses the brand "Freedom Mobile" for its wireless services, and Freedom Mobile was acquired in 2016 through acquisition. The company started cross-selling Freedom Mobile services within its Shaw store in Chinook Mall at Calgary in the past quarter. Management shared that they were "very, very pleased… and will look to continue to expand the availability of Freedom product within Shaw's retail footprint over the coming months."

Launching of services in Victoria and Red Deer

Shaw's Freedom Mobile currently has services in Greater Toronto Area (including Hamilton), London, Windsor, Kingston, Ottawa, Edmonton, Calgary, and Greater Vancouver Area. Shaw is expected to continue to launch its services in different parts of Canada in 2019. Management expects to expand to an additional population of 1.3 million, of which 1 million will be in Western Canada. Freedom Mobile expects to launch services in Victoria, BC, and Red Deer, Alberta in February 2019. We think the addition of these new services areas will help attract more customers, as Victoria and Red Deer are important areas in Alberta and British Columbia.

There is still a lot of room for Shaw and three large incumbents to grow in Canada

Many investors are concerned that Shaw will eventually face strong competition from the three major wireless services providers in Canada (TELUS, Rogers, and BCE). However, Canada's wireless environment is not as competitive as in the United States, and we do not foresee this to change anytime soon. Unlike the wireless penetration rate of over 120% in the United States, Canada's wireless penetration rate should still remain below 100% in the next 5 years. Below is a chart that shows the wireless penetration rate in Canada from 2010 to 2017. As can be seen from the chart below, Canadian wireless penetration rate has only reached about 85.5% in 2017. Based on the trajectory, we expect Canada's penetration rate to increase about 200 basis points every year. If our projection is correct, the penetration rate will not even reach 95% until 2022. In addition, Canada has one of the fastest population growth rates among the G7 countries thanks to its policy of welcoming immigrants. In fact, Canada receives over 300 thousand immigrants every year, and this represents over 60% of its population growth every year. This means that there is still room for the major 4 carriers to grow.

Source: Created by author; StatsCan; Statista

In this environment, we do not anticipate there will be aggressive price war from the three large incumbents as all of them added wireless subscribers in 2018 as well. Any price war is like a two side sword and can hurt their own margin as well. We do not anticipate Shaw will initiate a price war either as management indicated their intention to gradually increase its ARPU and grow its subscribers in the same time.

Voluntary Departure Plan should continue to reap benefits

Earlier in 2018, Shaw announced its Voluntary Departure Program. The plan was designed to reduce its workforce primarily for those technicians who come to each home to install cable TV or Internet services. Management believes that this service could be done through self-installation and thus reduce a lot of the expenses. This plan is expected to achieve a run rate annualized savings of C$215 million once fully implemented. In Q1 2019, cost-savings related to VDP were about C$25 million. Although the company is a little bit behind its plan, management believes they are on track to deliver C$140 million of VDP combined net operating and capital savings in fiscal 2019.

Shaw has the balance sheet to invest in wireless infrastructures

Investors might be concerned about whether Shaw has the balance sheet to fund its capital expenditures in wireless infrastructure. In fact, the company's net debt leverage ratio of 2.0x is quite healthy. Its leverage ratio is even better than the three large wireless incumbents (BCE: 2.7x; TELUS: 2.7x; Rogers: 2.5x).

Source: Q1 2019 Financial Report

Attractive Valuation

In its Q1 F2019 conference call, Shaw expects its 2019 EBITDA to grow by 4-6%. We think this number is slightly conservative, given the fact that its consolidated EBITDA in Q1 increased by 13% year over year. Using the high-end of its guidance range (6% growth), we estimate its 2019 EBITDA to be around $2.2 billion. Its EBITDA should grow to C$2.9 billion in 2022 assuming a growth rate of 10% year over year after 2020. Its Canadian peers currently trade at an average EV to EBITDA multiple of 8.0x. Using this multiple, we derived our target price for each of the years specified in the table below. Its price target of C$30 in 2020 is about 11.4% above its current share price. Including its annual dividend of C$1.19 per share, we have a total return of 15.8%.

	2018	2019F	2020F	2021F	2022F
EBITDA (C$ Mil)	$2,089	$2,214	$2,436	$2,679	$2,947
Growth Rate Assumption		6%	10%	10%	10%
EV To EBITDA	8.7	8.2	7.5	6.8	6.2
Price Target (Using EV to EBITDA of 8x)		C$27	C$30	C$34	C$38

Click to enlarge

Source: Created by author

Risks and Challenges

One of the biggest risks to Shaw's business is competition from its competitors. While we do not believe Canadian wireless market has reached saturation (as we have discussed earlier in the article), we cannot rule out a possible price war. Although there are no signs of a price war, if Shaw's Freedom Mobile begins to significantly take away other major players' market shares, these companies may retaliate and launch a price war to win back customers. Investors should keep this risk in mind.

Besides competition in the wireless market, Shaw also faces competition from its rival TELUS in its wireline business. As we have observed in the past two quarters, competition in wireline Internet has increased due to TELUS's deployment of FTTH. A price war may happen if TELUS decides to scale up its promotion.

Investor Takeaway

We believe Shaw will continue to perform well in the next few years with its wireless segment being its primary growth driver. In fact, we expect solid growth from its wireless business in the next few years. This growth potential, coupled with the defensive nature of the business, makes Shaw a good stock to own especially in a time of economic uncertainty. For investors with a long-term investment horizon, we believe the current share price is attractive.

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.

Analyst’s Disclosure: I am/we are long SJR, RCI, TU. 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.