BCE Inc.: A High-Quality Way To Play Canadian Telecom

|
About: BCE Inc. (BCE)
by: John Lawlor
Summary

BCE is a "widows and orphans" stock: a low-risk, attractively valued, large-cap, dividend-growth stock of a well-managed company for investors looking for defense, yield, and steady but modest growth.

The company is a hallmark of strong execution, which will continue to drive leading wireless ARPU and EBITDA growth in 2019 and beyond.

BCE possesses numerous strengths that promise investors superior long-term performance, including steady revenue growth, expanding profit margins, healthy cash flow from operations, and strong and a stable return on equity.

All financial figures are in Canadian dollars unless otherwise indicated.

The Bell Telephone Company of Canada - known today as BCE Inc. (NYSE:BCE) (TSX: BCE) - was incorporated by an act of the Canadian Parliament on April 29, 1880. It received through its charter the right to construct telephone lines alongside all public rights-of-way in Canada - in hindsight, a most valuable privilege at the time.

BCE Inc. was created in 1983 through a corporate reorganization whereby BCE became parent to over 80 companies previously known as the Bell Group, of which Bell Canada was the head. This reorganization was designed principally to cast off restrictions from the company's original charter that inhibited certain corporate acquisitions and investments.

BCE, Rogers, and Telus are Canada's three largest publicly traded telecommunications companies. All three are solid long-term investments for investors seeking a lower level of volatility. BCE Inc. is Canada's largest telecom services company, with 2018 annual revenue of $23.5 billion, and a market capitalization of $53.8 billion. BCE is also one of the most widely held stocks in Canada.

The company provides residential, business and government customers with a comprehensive suite of broadband communications and content solutions, including wireless, high-speed Internet, Internet Protocol (IP) TV, satellite TV, business IP broadband, and information and communications technology (ICT) services.

Through the Bell brand, BCE offers residential and business communications services, in seven out of 10 provinces, plus LTE (long-term evolution) advanced wireless communications services to more than 90% of the Canadian population across the country, including the largest network of data hosting and cloud centers.

BCE operates the most extensive network of communications retail outlets in the country - including national consumer electronics retailer The Source - and owns Canada's leading telecom provider, Bell Canada, which is the incumbent local exchange carrier for telephone and Internet services in most of Canada east of Saskatchewan and in the northern territories of the country.

Bell Canada's business segments include Bell Wireless, Bell Wireline, and Bell Media. Bell Wireless provides wireless services that are available to practically all of the Canadian population. The Bell Wireline segment includes voice and data networks, high-speed fiber solutions and Bell direct-to-home satellite television service. The company's fiber network is 240,000 kilometers in length - the largest in Canada - delivering Internet, phone and TV to more than 9.2 million locations across seven provinces.

Bell has the largest mobile network nationally, with Bell Mobility Inc. a division of Bell Canada providing wireless services across Canada. Bell Mobility and its affiliates combined have almost 10 million subscribers as of the end of the first quarter (Q1) 2019. Bell Mobility has the best coverage in the country, with virtually 100% of Canadians covered by its 4G LTE network. The network is also one of the fastest and most reliable nationally.

In May 2017, Bell acquired Manitoba Telecom Services Deal, Manitoba's largest telephone, internet and wireless company, significantly enhancing Bell's network coverage area. Prior to this purchase, Bell's network covered only the Winnipeg to Brandon corridor in Manitoba, whereas MTS's network was the largest in Manitoba, covering all of Manitoba, with the exception of the Far North.

Bell Canada provides mobile service through its Bell Mobility subsidiary and television through its Bell TV and Bell Fibe TV subsidiaries. Other interests include Bell Media, Bell Aliant, and Bell MTS Inc.

Source: Getty Images

The Bell Media segment is Canada's premier multimedia company with leading assets in television, radio and digital media, including Canada' most-watched television network CTV; the most-watched specialty channels, including the top Canadian sports network TSN; and Canada's premium streaming service, Crave.ca.

BCE generates about 54% of its sales from wireline broadband and television, 35% from wireless, and the remaining 11% from the company's media operations. BCE is also a significant investor in Canada's iconic sports teams, the Toronto Maple Leafs and the Montreal Canadiens.

Investment Thesis For BCE

In presenting the investment thesis for a company's shares, I do so from the perspective of a "part owner" of the underlying business. As a result, I try to think like an owner; I have a long investment horizon. Long-term investing in equities is buying and holding a stock you believe will compound investor wealth indefinitely into the future. My favorite holding period is "forever."

When I make an investment decision, I am not looking to hit the ball out of the park - singles and doubles will suffice. But I do try to avoid striking out. I seek safety to avoid disasters. I define "disaster" - and "risk" - in four words: "permanent loss of capital." I don't think of volatility as risk; volatility and risk are not the same thing. When a stock is volatile, it means that it tends to make big moves - up or down. When a stock is risky, it means that it can lose money - that is, go down. Volatility can be an opportunity if it presents the occasion to acquire incremental ownership of a quality company when a bipolar Mr. Market causes it to go on sale temporarily.

To sum up my investing methodology in four compound words, it is "Long-Term, Large-Cap, Value-Oriented, Dividend Growth." This is not everyone's approach to investing in equities. However, if it is not your investing style, you are not likely reading this article on BCE Inc. in the first place.

Not every stock is a wonderful business. It is an exclusive list. At the top of the list is being the market leader and possessing a strong and stable management team. It encompasses qualities like a large market cap and critical mass; a durable, easy-to-understand business model; distinguished corporate and dividend histories; and an iconic brand, which leads to consumer awareness and loyalty. For me, these qualities combine to form a "sleep-well-at-night" or "forever" stock, as I call them.

BCE Inc. One-Year Stock Chart

Chart

Data by YCharts

BCE Inc. 10-Year Stock Chart

Chart

Data by YCharts

In this vein, last year, BCE's operating company Bell Canada placed third overall in the rankings for Canada's most valuable brands, challenging the country's "Big Five Banks" as the only company in the top five from outside the financial services sector. Equally important, Bell's brand value is one of the fastest growing as well, increasing by 38% in the past two years.

BCE possesses numerous strengths - which promise investors superior long-term performance compared to most stocks - strengths that include its steady revenue growth, expanding profit margins, healthy cash flow from operations and strong and stable return on equity (ROE).

BCE is a reasonably-valued, low-risk, low-volatility (β of 0.22), dividend-growth stock, which currently yields 5.3%. The company is the overall leader in the manageable communications services sector in Canada, with its high barriers to entry. Three major Canadian telecom service providers, BCE Inc., TELUS Corporation (TU), and Rogers Communications (RCI), control the market in Canada. This results in relatively smooth and safe revenues and earnings for all three companies.

Smartphone penetration in Canada is still quite low for a developed country. About 85% of relevant Canadians own a smartphone. This percentage continues to grow and is permanently in the "replacement market" phase as well. For example, 34% of Canadians are planning to purchase or upgrade to a new device in the coming 12 months. As the smartphone installed base grows and turns over, so too does the incumbent demand for newer replacement models. According to market research firm Catalyst, the mean number of smartphones ever owned by the current owner grew almost 15% last year, from 2.1 to 2.4 devices.

As the largest generational cohort in North America since the Baby Boomers, Millennials are more connected than any other generation and are playing a key role in the evolving mobile landscape, as they are driving most of the growth across smartphone activities and replacements. These sectoral characteristics add up to a long growth runway for BCE's wireless business.

Under George Cope, who became CEO of BCE Inc. in 2008, following the failed $52 billion takeover attempt by Ontario Teachers' Pension Plan and its investment partners, Providence Equity Partners International and Madison Dearborn Capital Partners.

Under Mr. Cope's leadership, in the area of IP television, BCE has grabbed the leadership position from TELUS with its popular IPTV offering. In the wireless segment, it posted another quarter of strong results in its fiscal first quarter to kick off 2019. And on the broadband side as well, the company has catapulted to the leadership position in market share. These core segments are the primary future revenue drivers for BCE.

On the media side, Bell Media is the number one media asset in Canada. Its content portfolio is solid, including control of Canada's largest private TV broadcaster CTV and a controlling stake in TSN, Canada's version of ESPN and the country's most popular sports network. BCE also benefits from a network sharing agreement with TELUS where the two companies divvy up the upgrade and maintenance of their joint nationwide network.

BCE Inc.'s Bell Canada is leading in the high-stakes race to satisfy consumers' seemingly insatiable demand for constant connectivity, faster download speeds, and more reliability. The company is spending $20 billion to upgrade its broadband and mobile networks, including building out its optical-fiber network to power new broadband services. Called Gigabit Fibe, the service delivers the fastest Internet speeds available, with download speeds of up to one gigabit per second.

Bell's investment comes as Canada's cable and phone companies are fighting an escalating battle. The rise of streaming services have taken a significant bite out of the traditional cable business and are placing increasing demands on networks just as the sheer number of connected devices is also on the rise. Add to the mix an increased use of applications such as video conferencing, file sharing and online gaming, and it is clear that the thirst for data will only intensify. By 2021, according to estimates from networking hardware company Cisco Systems Inc., global Internet traffic will be 127 times what it was in 2005.

BCE's objective is to bring fiber to every home in its expanding operating territory to provide consumers with increased capacity in their thirst for new services. The Internet will continue to be a rapid area of growth for the company. Wireless is also continuing to grow. Video usage is exploding. A few years ago, a household might have had two computers connected to the Internet. Now there are five or more devices and, ultimately, every "appliance" will be plugged into these broadband pipes.

Source: Google Images

If you had bought the stock when Mr. Cope took the reins of the company in 2008 (which is when I purchased a full position in BCE) you would be up 230%, not including dividends. Considering the strength and safety of its business model, its long-standing, entrenched market position, and its growth prospects, BCE offers an attractive combination of high yield, dividend growth, and modest capital appreciation.

BCE has the largest mobile network nationally, with Bell Mobility Inc. a division of Bell Canada providing wireless services across Canada. Bell Mobility and its affiliates combined have almost 10 million subscribers as of the end of the first quarter of 2019, making it Canada's second largest wireless carrier.

Bell Mobility has the best coverage in the country, with 99% of the Canadians covered by its 4G LTE network. The network is also one of the fastest and most reliable nationally. Bell-owned Virgin Mobile Canada and Loblaw's (TSX: L; OC: OTCPK:LBLCF) prepaid PC Telecom, operate as mobile virtual network operator (MVNOs) on the Bell Mobility network, offering generally lower-priced plans with the same great Bell Mobility coverage.

In May 2017, Bell acquired Manitoba Telecom Services Deal, Manitoba's largest phone, internet and wireless company, greatly enhancing Bell's network coverage area. Prior to this purchase, Bell's network covered only the Winnipeg to Brandon corridor in Manitoba, whereas MTS's network was the largest in Manitoba, covering all of Manitoba, with the exception of the Far North.

Strong Dividend Growth Story

I believe the best way to build wealth in the stock market is to buy quality stocks - solid businesses with reliable dividends; companies that are so reliable that you can purchase them today and hold for the rest of your life - then reinvest the dividends and let the power of compounding, which Albert Einstein described alternatively as "the eighth wonder of the world" and "the most powerful force in the universe," do the rest.

Source: Google images

Telecom and utilities are two sectors that have traditionally paid the highest dividends. The average telecom stock pays a yield of about 4.5%, while utility stocks pay about 3.5% on average.

Novice income investors often look for the highest-yielding dividend stocks, thinking more is more. What they fail to realize is that is a riskier proposition than finding companies with more reasonable current yields that consistently grow their payouts over time. There is no better indication of a shareholder-oriented management team than a history of growing dividends.

Highlighting BCE's sound financial position, the company has raised its quarterly common share dividend by 5% or more 12 times since the fourth quarter of 2008 for a total percentage increase of 87%, to $0.793 per share quarterly or $3.17 annually, for a current yield of 5.30%. This places BCE seventh among top-yielding S&P/TSX 60 listed companies.

BCE has set a target for its dividend payout ratio at 65% to 75% of free cash flow. The company believes this policy will allow it to grow its dividend for its shareholders and, at the same time, continue to invest adequately in the future of the business and maintain an appropriate level of balance sheet liquidity.

Strong Management Team

The management of a publicly traded company is in charge of creating value for shareholders. A great business in a great sector can be destroyed by poor leadership. If you doubt this, think back to the disasters of Jonathan Schwartz at Sun Microsystems, Chuck Conway at Kmart, Eckhard Pfeiffer at Compaq, or John Sculley at Apple (AAPL), who made numerous mistakes, the most egregious of which was to fire Steve Jobs.

Strong CEOs attract and retain strong talent. Some say that the true value of management will be reflected in the company's performance and the stock price. I believe this is true over the long run, but a strong performance in the short run does not necessarily guarantee quality management. The best example is the downfall of dot-coms. Their stock prices were believed to be a sure sign of success. However, the market can behave strangely in the short term. Strong stock performance alone does not mean you can assume the management is of high quality.

My first step in making an investment decision is to examine carefully the executive team to satisfy myself that it is composed of exceptional leaders with years of relevant industry experience and a demonstrated record of achievement.

BCE has exceptional C-level bench strength - arguably the best in Canada. And BCE CEO George Cope is among the best CEOs in Canada. Mr. Cope was named Canada's Outstanding CEO of the Year in 2015. The prior year, BCE posted net earnings of $2.5 billion, a long way from the C$943 million it reported in 2008, the year Mr. Cope became CEO. In that same year of 2018, he unleashed a turnaround plan to cut costs and jolt the then lethargic telecom operator, which was losing market share to rivals. Mr. Cope established six strategic imperatives for the company at the time, which have remained the bedrock for executing and measuring the company's performance to this day:

  1. Invest in broadband networks and services
  2. Accelerate wireless
  3. Leverage wireline momentum
  4. Expand media leadership
  5. Improve customer service
  6. Achieve a competitive cost structure

Q1 FY16 Results Steady Across the Board

BCE started strongly in 2019, reporting better than expected first-quarter 2019 results on May 2nd and reinforcing my positive view of the company. CEO George Cope acknowledged on the conference call with analysts that the first quarter is usually a seasonally slow sales period for wireless, but Bell was helped by a large federal government contract that began to roll out last year.

Overall, BCE's Q1 2019 was one of modest organic growth with minimal surprises or disappointments. The 12% year-to-date gain for BCE shares - which has undoubtedly been aided by declines in interest rates - makes it difficult for me to rate the stock a "Buy," however, I continue to view BCE as a safe, stable, and well-managed company for investors looking for defense and dividend yield plus growth.

From a Bell Mobility perspective, I was pleased to see evidence that reduced promotional activity and selective rate increases year-to-date is leading to a recovery in average revenue per user (ARPU) growth trends, which should be a nice offset to a more modest (but still solid) pace of subscriber additions in 2019.

BCE's consolidated revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) were $5.73 billion, up 2.6% year-over-year (YoY) and $2.41 billion, up 6.9% YoY, respectively, versus analysts' consensus estimates of $5.71 billion and $2.37 billion. The positive EBITDA variance was mainly due to higher EBITDA margins at Bell Media. Consolidated EBITDA margins were 42.0%, up 1.8% YoY versus, while adjusted earnings per share (EPS) was $0.77 versus consensus of $0.76.

BCE's wireless business performed well in the first quarter, with its revenue up 4.5% YoY to $2.11 billion, helped by improved subscriber retention and higher average revenue per user. Wireless EBITDA was $905 million, up 11.6% YoY and versus consensus of $895 million.

The company's first-quarter profit was up 12% from a year earlier, with the wireless division leading the growth. BCE's wireline business, which includes residential internet and TV service, grew revenue by 1.8%% to $3.06 billion.

Service revenue grew 1.6% to $5.05 billion and product revenue increased 10.1% to $689 million, reflecting increases at Bell Wireless and Bell Wireline, partly offset by a modest year-over-year revenue decline at Bell Media.

BCE took subscriber share in both wireless and retail wireline. The addition of 50,204 net new postpaid subscribers was down from 68,487 a year earlier, but better than analyst estimates of 47,000 and more than twice the 23,000 net postpaid additions announced by is major rival Rogers Communications Inc. Two other important metrics used in the wireless industry - churn and average revenue per user - also moved in the right direction during the quarter.

BCE's wireless and retail wireline revenue and adjusted operating income before depreciation and amortization (OIBDA) growth of 4% was at the high end of the company's 2019 guidance. Management highlighted positive underlying momentum seen across the business, including wireless average billing per user (ABPU), enterprise wireline, and media advertising. And the company confirmed its continued confidence in a network-investment led strategy, including its interest in the upcoming 3.5 GHz spectrum auction.

BCE's net profit amounted to $740 million attributable to common shareholders or $0.82 per share, which was up from $661 million or $0.73 per share in the first quarter of 2018. The Montreal-based company's adjusted earnings per share were $0.77, down from $.80 per share the prior year and one cent below the average analyst estimate. Analysts had estimated $0.78 per share of adjusted earnings and $5.71 billion of total operating revenue.

However, shares slipped 0.2% the following day, after a pair of equity analysts downgraded its stock. Citi analyst Adam Ilkowitz said he continues to like BCE's operating strategy, "steady" execution and the dividend growth that it provides with "the positive" Canadian telecom market. However, Mr. Ilkowitz downgraded his rating for its shares based on the premium it now trades at relative to its peers and with the view that he cannot increase valuation multiples in the current environment: "Wireless subscriber activity levels were lower in the first quarter of 2019, but market growth does not appear to have slowed as much as feared, following Rogers results."

Rogers Communications Inc. experienced an unusually slow first quarter. Net income was $391 million or $0.76 per share for the quarter ended March 31. That compared with a profit of $425 million or $0.80 per share a year ago when Rogers, which owns the Toronto Blue Jays, received a special payment from Major League Baseball. Revenue totaled nearly $3.59 billion, down from $3.63 billion in the same quarter last year. Rogers attributed the revenue decline to lower sales of wireless equipment, such as smartphones, and lower revenue from its media division, which includes the Blue Jays.

Canada is approaching 90% wireless penetration and customer growth is likely to slow unless there is an uptick in tablet or wearable connections. Mr. Ilkowitz stated he continues to like Bell's investment-led broadband strategy and sees significant upside to sell into the fiber-to-the-home (FTTH) base, which is just 27% penetrated.

"The premium valuation is warranted due to consistency of execution and results, but it is hard to extend further, given the structurally lower growth profile of BCE," he said.

BCE Inc. Share Price Action Following Q1 2019 Results Announcement

Chart

Data by YCharts

With the stock trading at an above-average premium to its peers, Desjardins Securities Maher Yaghi thinks further outperformance "will be more difficult, especially given our earnings growth expectations." That led him to drop BCE to "hold" from "buy" with a $65 target, down from $66.

"Management has done an excellent job in continuing to better position BCE to compete for a larger share of spending in the sector," Mr. Yaghi wrote in a research note to clients. "Cost reductions and significant capital investments in FTTH and wireless have built a protective layer around the company's assets, which should last for many years. However, with the recent decline in interest rates, valuations in the sector have shifted in search for yield, tilting the valuation of BCE's stock to a significant premium versus its peers."

Investment Thesis For BCE

Given BCE's position as a defensive, liquid, dividend-growth stock and bond proxy, I expect the stock to remain sensitive to changes in macro expectations, in particular, interest rates and the overall macro economy. Irrespective of macro factors, the underlying company fundamentals remain solid, driven by:

  • Mid-single-digit wireless EBITDA growth;
  • Steady Internet and IPTV net additions leveraging an expanding FTTH footprint;
  • A strengthening business market in Canada;
  • Moderating consolidated capital expenditures in 2019 and beyond;
  • Further ongoing cost improvements/efficiencies.

My one-year price target price of $63.00 is based by applying a 16.0x multiple to the blended two-year forward EPS estimates. My target multiples are consistent with the peer group and with BCE's relatively high EBITDA-to-FCF conversion rate and a low interest rate environment. BCE's shares are trading at 8.1x 2019E EBITDA, which compares with its normalized long-term historical range of 6x‒8x.

Coupled with industry-leading execution, I view BCE as a high-quality core holding in Canadian telecom.

Potential Risks

There is no such thing as a risk-free stock. In fact, there is no such thing as a risk-free return. Most people only associate risk with loss. While stuffing the money under the mattress will avoid stock market risk, it simply exposes that money to other risks, such as purchasing power risk, or inflation risk; that is, the "risk of avoiding risk."

I have described BCE as a "widows and orphans stock," in reference to its relative safety; however, the stock is exposed to risk from a reversal of macro drivers, such as higher interest rates and bond yields, or a reversal in fund flows out of the sector. In addition, new wireless, wireline or television regulation, or the emergence of irrational pricing in the wireless, residential telephony, television, or Internet business segments could pose a risk to the business.

Specific risks to BCE's stock include the following:

  • Aggressive pricing or promotions from cable and VoIP providers could reduce Bell's profits in wireline, wireless, residential telephony, television, and/or Internet markets
  • Increased wireless competition from new entrants or among the three incumbents
  • 5G wireless services could evolve into substitutes for the fixed-line broadband services offered by Bell today
  • Regulatory changes could negatively affect Bell's operations
  • Escalating capex for fiber to the home (FTTH) or other major projects could lead to elevated capital expenditures and lower free cash flow (FCF)
  • Overpriced acquisitions
  • Rising Interest rates
  • Inability to realize additional annual cost savings to maintain wireline margins

Conclusion

Thank you for making it this far in the article. I enjoy researching and writing articles on quality companies for Seeking Alpha. Investing is a hobby of mine, as is writing, and it is rewarding to be able to productively combine the two hobbies. I had a long career in finance and investor relations, which meant I was closely engaged with both sides of the Street - buy side and sell side analysts and portfolio managers - on a daily basis. I have read thousands of sell-side equities analysts' research reports. Professional fund managers and sell-side analysts are short-term focused. They have been conditioned to be so, as they are measured and rated on a quarterly basis.

My investment horizon is substantially longer. In fact, my ideal holding period is forever. I strive to provide a more detailed, long-term-focused analysis of companies I research.

The true value of my articles stems from the insightful comments from Seeking Alpha members, and I continue to learn from the readers' comments on my articles. Collectively, your comments give me a prized opportunity to tap into the "wisdom of the crowd." Seeking Alpha members' comments continually reinforce for me how investing decisions must revolve around our personal investment and financial goals, which are as unique as we are.

Please share your thoughts in the "Comments" section beneath this article. With so many informed authors and readers, I find I learn as much from the insightful and value-add comments from readers as I do from researching for the article itself.

I recognize that BCE Inc. may not be for every investor, as each individual investor has their own unique investment and cash flow objectives. To understand why I recommend and continue to own BCE and why I consider the shares to be a long-term hold, it is helpful to have knowledge of my investment approach, which can be summarized in four compound words: quality-value, large-cap, dividend-growth and long-term. For additional details, please refer to an interview conducted by Canada's leading business newspaper, The Report on Business section of The Globe and Mail, entitled "A Long-Term Outlook Helps This Investor Weather Market Volatility."

I focus on companies that fit this four-phrase description. BCE Inc. fits this mold, and I will continue to hold my full position in it, ideally, "forever."

The focus of my articles for Seeking Alpha is on attractively valued, large-cap, dividend-growth stocks with sound business models, strong management teams and wide economic moats - "Forever Stocks," as I like to call them. I strive to provide an in-depth analysis of the companies I research. I wrote this article from the perspective of a long-term investor who follows a straightforward, four-part strategy:

1. Identify a company with strong competitive advantages.

2. Satisfy myself its competitive advantages are enduring.

3. Invest in this company when it is trading at a fair price.

4. Hold the stock "forever," unless there is a significant change to the fundamental investment thesis associated with the company.

If you found this article helpful, please "Follow" me on Seeking Alpha to receive a notification whenever I publish a new article.

Disclosure: I am/we are long BCE. 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.