RCI.B:CC - BCE: For Whom The 7% Bell Tolls

2023-08-10 10:00:00 ET

Summary

• Q2-2023 results for BCE were mixed, with revenue growth exceeding expectations but other metrics falling short.
• The media section of BCE has been struggling, with revenues and adjusted EBITDA declining.
• BCE is the best-placed out of the three Canadian telecom players based on two critical metrics.

Note: While the stock discussed trades on both NYSE and TSX, all references pertain to the stock trading on TSX and all amounts discussed are in Canadian Dollars

On our last coverage of BCE Inc. ( BCE ) ( BCE:CA ) we gave it a positive review. But there was still some amount of valuation oomph lacking to go in with a "buy". We thought we would get a better entry as value stocks had a selloff in response to the higher risk-free yields. So we went with a hold while noting what exactly it would take to make that last leap.

If you envision an earnings multiple of AT&T ( T ) or an EV to EBITDA multiple of Verizon Inc. ( VZ ) at the end of your 10-year cycle, you can see the horrors of this forecast. This is a major danger with the stock trading at a very lofty valuation relative to risk free rates. At present, we rate it at a hold and would get interested if we saw something close to a 7% dividend yield. We will add here that we like it the most out of the three Canadian telecom players, but we still won't buy the common shares.

Source: Fantastic Yield But We Are Likely To Get A Better Entry

December 5, 2022 seems like a long time back. But if you waited, you got your "better entry".

The stock just hit a 7% forward yield intraday. Let's look and see if the Q2-2023 results and the macro environment support a buy today.

Q2-2023

Q2-2023 results were a mixed bag. Revenue growth came in a bit stronger than expected with a 3.5% growth, but all other metrics seemed to fall short.

Notable was that adjusted EBITDA only increased by 2.1% and EBITDA margin dropped. The worst outlier appeared to be the capex spend which was 7.2% higher (shown as negative 7.2% in the slide above). Management did highlight that this was more of a timing issue but it did catch most analysts by surprise.

On segment basis, Bell Communication & Technology did great on the revenue front with residential internet up 7%.

Bell Media though was where we saw the struggles and revenues dropped 2%. This was amplified on the adjusted EBITDA front where we saw a 5.3% decline.

The media section has been under pressure for some time and it might seem unusual to investors who associate this occurrence to be only natural during recessions. But there has been an influx of capex into the media sector (think streaming growth) and that usually creates poor returns for all players.

Outlook

The idea with telecom stocks is that they are quasi-oligopolies that can charge whatever they like to a captive market. But the reality is that there is always some competition and pricing power is modest for an interchangeable product. Canada's telecom landscape is a bit better than the US as the immigrant influx is higher and boosts subscriber growth over time. BCE is the best placed out of the three which include TELUS Corporation ( TU ) ( T:CA ) and Rogers Communications ( RCI ) ( RCI.B:CA ). We base this on the fact that the fiber rollout for BCE is in the more advanced stages and it should have better free cash flow metrics down the line. We also base this on the net debt to EBITDA for BCE which is 0.3X lower than TELUS and 1.2X lower than Rogers Communications. BCE also has the largest yield of them all, though the coverage via free cash flow looks iffy until we get to 2025.

On an EV to EBITDA basis, all three are about the same for 2023 (8.2X-8.4X) but most analysts expect TELUS and Rogers Communications to grow faster in 2024. We don't think that will pan out and all three will slog away in a similar manner should we hit a recession.

If we look towards history this 8.2X EV to EBITDA is on the cheap side, though a lot of the comparative years were the bubble years where cost of capital was suppressed. In a similar manner, the dividend yield on BCE seems high relative to the last 20 years. But if you run a subtraction versus the risk-free rates (whether you use 1-year Canadian Government bonds or 5-year ones), BCE's yield looks average. The key question comes down to whether you expect these high rates to persist or not. If you do, and are correct, then BCE will likely give you an even lower entry point. If you don't think rates can be sustained this high, and are correct, then this is your entry point. Buy in.

Verdict

We are in the camp that zero interest rate policy is now in the past. While we will get rate cuts in a recession, the 0% era is likely behind us for foreseeable future. So that gets us to a middling stance where we would like to buy here but not go crazy with our purchases. Another way to layer in positions is via covered calls near the $55 strike. We like the March 2024 calls for that purpose.

The return profile is decent and gives us an effective entry price well over a 7% yield. BCE gets a 4 on our potential pain scale rating at the current price.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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