If you want to earn exciting returns in the stock market, it pays to own boring businesses.
As regular readers know, I tend to gravitate towards companies that “sell the basics.” Simple products – bleach, coffee, and trash collection – don’t make for the best gossip around the office water cooler. But these businesses enjoy steady demand, which translates into outstanding compounded returns over the long haul.
Case in point: BCE Inc. (NYSE:BCE). The Canadian telecom giant provides landline, wireless, and internet services to millions of people across the country. The company also represents one of the oldest dividend stocks in the world, paying out distributions to shareholders for over a century.
But does BCE stock present a good place to put money to work today? Let’s take a deep dive into this distribution.
'Selling the Basics' Pays Off For Shareholders
BCE pays one of the safest dividends around, to begin with. Telecom represents an essential service; a bill people won’t stop paying in the event of a recession. The high cost of building a rivals telecom network from scratch also keeps all but the most deep-pocketed competitors out of the business. But because government regulations prevent foreign companies, incumbent firms enjoy most of the market to themselves. As a result, Canada telecom firms enjoy some of the highest profit margins in the world. Last year, BCE’s gross margins topped 70%. Operating margins came in at 23%. Moreover, over the past five years, the business has generated over $0.20 on average in profit on every dollar of equity invested in the business over the past five years. That indicates a wide competitive moat around operations, resulting in outsized returns year after year.
Management also runs the company’s financials in a conservative fashion. Next year, Wall Street projects the business will earn $2.88 per share. Over the same period, the current dividend stands of $2.37 per share annually. By and large, I like to see businesses pay out 90% or less of their earnings to investors. This leaves some wiggle room to keep making payments in the event of a downturn. BCE’s 81% payout ratio sits well within my comfort zone.
The only thing that could raise concerns? BCE’s balance sheet. Over the past few years, the company has invested heavily into its network. Those investments will pay off down the road, but it has stretched BCE’s financials slightly in the short-term. Today, BCE has $36.6 billion in outstanding liabilities. The company’s debt-to-equity ratio stands at 0.97 - slightly above industry peers. That said, BCE’s predictable cash flows should allow the company to finance this debt load with little problem. Still, it’s a risk to keep an eye on.
Source: MSN Money
Moreover, the company offers investors a growing stream of income. BCE has increased its payout for 10 consecutive years. Over that period, the dividend has grown at a 7.5% compounded annual clip. Today, shares pay a quarterly distribution of $0.76 per share, which comes out to an annual yield of 5.3%.
Management has three avenues to grow that distribution even further. First, raise prices. Earlier this year, BCE hiked the cost of its monthly internet plan on customers by $5.00 per month. With few other options, management has had no issues passing on price hikes to customers for mobile and television packages. Second, offer more bundle packages. By combining different services, BCE increases the friction for customers to change to a different company in the future. This will make it easier to raise prices. Third, roll out new 5G services. BCE’s fiber-optic network positions the company at the forefront on the coming 5G boom. With more devices demanding more mobile data, the company will enjoy robust profit growth.
These efforts should translate into respectable growth for shareholders. BCE’s CapEx budget has averaged $4.0 annually over the past five years to fund its expansion. Over the next five years, analysts project the company’s earnings per share will grow at a mid-single-digit clip. Investors can expect their distributions to grow more or less in line with profits.
And investors may now have a rare chance to scoop up shares at a reasonable price. Over the past five years, BCE’s stock price has traded sideways. That has allowed earnings to catch up with the company’s stock price.
This should result in respectable returns for shareholders. Today, BCE pays an upfront yield of 5.3%. Assuming a dividend growth rate of 4% to 6% per year, our total return expectations jump to about 10% annually. That might not impress some people, but it meets my hurdle rate for a wonderful business like BCE.
Of course, you can’t call BCE a slam dunk. Telecom companies always face the risk of closer government oversight. We’ve seen these measures hurt profits in the past, such as regulators banning long-term mobile contracts. If the government felt BCE was treating customers unfairly, they could always impose more severe regulations or attempt to increase industry competition.
New competition could also bite into margins. In recent years, regional-rival Shaw Communications Inc has entered into the marketplace with its new Freedom Mobile offering. Shaw has drastically undercut national competitors on price to build its customer base. And because of the company’s cash cow landline business, Shaw has the ability to withstand short-term losses. I have my doubts Shaw’s expansion plans will pay off for shareholders, but there’s no doubt their presence could bite into BCE’s quarterly results. It’s something investors should keep an eye on.
The Bottom Line on BCE Stock
I can’t predict how BCE’s stock will perform over the next quarter or two. I suspect, though, people will still want to talk to their friends, stream their favorite movies, and surf the internet in 20 or 30 years. That should translate into dependable cash flows and a growing stream of dividends for shareholders.
That’s the benefit of investing in companies that sell the basics.
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.