CA - Rogers Communications: EBITDA Growth And Balance Sheet Deleverage Story Continues

2023-12-19 11:31:23 ET

Summary

• Strong financial performance and EBITDA growth outlook support a buy rating for Rogers Communications.
• Wireless segment shows promising growth with improved pricing strategy and increased ARPU.
• Cable segment demonstrates signs of growth recovery with market share gains and improved penetration rates.

Investment Action

I recommended a buy rating for Rogers Communications ( RCI.B:CA ) when I wrote about it the last time , as I expected valuation to improve as RCI EBITDA grows and it de-levers its balance sheet. Based on my current outlook and analysis of RCI, I recommend a buy rating. RCI's financial performance is on track against my expectations, and the EBITDA growth outlook remains healthy. Importantly, I do not see any major hurdles to further deleveraging the balance sheet. The market has already picked up on the recovery momentum (as seen from the share price), and so long as RCI continues to perform as I expect, the share price should reflect my target price over time.

Review

A great 3Q23 quarter for RCI, showing more evidence that EBITDA can continue to grow. In the quarter, RCI reported total revenue of $5 billion, with $4.5 billion from service revenues (the focus of the business) and adj. EBITDA of $2.4 billion (~12% y/y growth, with margin expanding to 47%). At the earnings level, RCI reported adj. EPS of $1.27, outperforming the market expectation by a big margin ($1.27 vs. $0.18). Importantly, RCI continued to generate a strong FCF of $745 million in the quarter. As of 3Q23, the RCI net debt position to EBITDA ratio has improved by 0.45x, reducing from ~5.1x in 2Q23 to 4.6x in 3Q23.

My expectation for RCI is playing out nicely. Strong EBITDA growth coupled with reduced leverage led to a strong share price reaction (now 10+% above the share price when I last wrote about it). I expect this EBITDA growth momentum to continue as the current trend persists in the wireless and cable segments.

For the wireless segment, I continue to expect strong RCI wireless loadings to persist, driven by an improved Rogers brand value proposition (better pricing and bundling strategy), strong retail distribution channels, immigration growth, and industry rationalization. Regarding value proposition, RCI's revamped pricing strategy should provide a tailwind to mobile phone ARPU. The revised ARPU strategy has two impacts. Firstly, the increase in headline prices directly drives an increase in revenue. Secondly, it entices flanker 4G subscribers that are unwilling to upgrade to the 5G network because of the price of upgrading. This strategy effectively pushes a bunch of subscribers to upgrade, which makes it easier for RCI to justify a price increase in the future as 5G offers more value (i.e., speed). The latter is apparently working out just fine, as evidenced by RCI organic ARPU growth in 3Q. From a percentage growth perspective, ARPU growth momentum should sustain in the near term as RCI faces easy competition as Shaw Mobile subscriber churn headwind eases. RCI's ability to raise prices is coherent with the narrative that industry competition is rational, which suggests the possibility of further price increases. I was worried that the competitive intensity would pick up during the back-to-school period, but surprisingly, management mentioned that the market was in good health, indicating that there weren't major price wars.

And so, from a broad environment, we continue to see good health in the market. 3Q23 call

For the cable segment, while net adds decelerated from 25k to 18k, it was still a y/y improvement (3Q22 saw 11k net adds). After price cuts, network upgrades, and bundle initiatives, I see this as a first indication of growth recovery in Shaw's legacy footprint. Key reason for me saying that this is an early sign of growth is that RCI is beginning to see penetration rates improve in both the East and West. With the new passing coming up, if the net adds and penetration continues, it will further crystalize the narrative that growth is back.

In cable, we saw market share gains accelerate across the East and the West. These gains are driven by our new bundled offers, our network investments, and our 5G leadership. In the quarter, we added 18,000 internet customers. 3Q23 call

Making the EBITDA growth outlook even better, management has raised their 2023 synergy realization target to $360 million, a $160 million increase (or 80% delta) from the previous target of $200 million. What was puzzling to me is that management left their EBITDA guidance unchanged, and I take this as a sign of conservatism, which gives management more room to be aggressive in marketing and promotions to capture share in 4Q. Nonetheless, it is good to know that management is able to extract more than target synergies.

In terms of leverage, RCI has made good progress in deleveraging, and I don't see any major obstacles that could stop this. In fact, management seems to be hinting at potential asset divestments, and I expect they will be using the cash proceeds to pay down debt. In the call, when asked about non-core asset sales, management replied:

Thanks Vince. Yes, we're still working through a process on a few different exercises and still confident on the timeframe of hopefully having announcements in year and closing, again, still looking to close if not in year this year, certainly first half of next year for a number of those. 3Q23 call

Hence, I think the path to deleveraging is pretty visible. EBITDA should continue to grow, driven by topline growth and more synergies. Improved EBITDA, coupled with debt paydown (organic FCF and cash proceeds from sales of non-core assets), should easily drive leverage down to peers' levels (at 3+x net debt to EBITDA). Using consensus FY25 EBITDA and FCF estimates, I think net debt to EBITDA has a viable path to <4x.

Valuation

I have turned more bullish in my growth assumptions for RCI, given the updates provided in 3Q23. My previous assumption was that growth would come in at the low end of the guided range (26%), but I am now revising it so that it meets the high end of the guided range (30%). For FY24, my growth assumptions remain the same at 8% (higher than the historical rate of 5%), as RCI should continue to enjoy the positive impacts from the initiatives rolled out in FY23. FY25 growth will normalize back to 5%. Margin expectations remain largely the same (I switched to using EBITDA as it is easier to compare against peers with lower leverage), and I expect high incremental margins to drive margin upside. As these assumptions play out, leverage should continue to come down, likely touching below the 4x ratio (very close to peers' level). This should help drive valuations upward, above the historical average, as the balance sheet will be much stronger.

Risk and Final Thoughts

Downside risk includes lower-than-expected wireless and broadband net adds due to either macro pressures or product failure that causes reputational damage. An increase in cable passings could drive up CAPEX much more than expected, impacting the timeline of deleverage. Lastly, if competition flips to become irrational, it would make the RCI pricing strategy less impactful.

My concluding thoughts are that RCI remains buy rated as performance aligns with expectations, showcasing robust EBITDA growth and a promising trajectory for balance sheet deleveraging. The wireless segment's performance remains promising, bolstered by strategic pricing initiatives driving ARPU growth. Moreover, cable segment improvements signal growth recovery, with increased market share across regions. Management's upward revision of synergy realization targets and potential asset divestments are positive news for continued deleveraging.

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