RCI - Rogers Communications: Everyone Keeps Ignoring Good News

2023-05-26 09:48:27 ET

Summary

• Rogers Communications Inc. closed a long-awaited merger with Shaw Communications on April 3, 2023.
• The merger comes with C$1 billion in synergy benefits, and the Q1 earnings guidance of the combined companies showed over C$2 billion in cash flow.
• I believe Rogers Communications is a buy as valuation multiples are depressed, and the market hasn't reacted to the good news from the merger.

Rogers Communications Inc. (RCI) provides various comprehensive communication services to millions of Canadians. Since the merger with Shaw Communications was finally approved, management has laid out an aggressive plan to drive C$1 billion in synergies and detailed benefits of their newly found scale. In addition, Q1 earnings guidance for the combined company was impressive, with a free cash flow of over C$2 billion. I rate this stock a buy as I believe that Rogers Communications is undervalued at the current share price while the market continues ignoring good news.

Shaw Merger Finally Closing Changes The Game

In March 2021, Rogers Communications announced a C$16 billion deal to purchase Shaw Communications. While it took two years for the Canadian government to approve the deal, it finally closed on April 3, 2023 , for C$20 billion. This acquisition makes Rogers the largest telecom provider in Canada by a wide margin. The deal will enable Rogers to increase its market share and customer base while leveraging synergies across the two businesses.

Two things really stuck out to me during the Q1 2023 earnings call .

First, the company has an aggressive plan to drive C$1 billion in synergy value. Analysts dug into the timing during the call, and management confirmed the savings are not backloaded, with C$200 million coming in the 2023 results. Additionally, management spoke to the breakdown of the savings, primarily driven by headcount, media content, and general vendor costs.

Second, the scale of the combined business drives benefits beyond synergy. This goes beyond the benefit of being the most prominent national carrier in Canada and covering the country coast to coast, a point that has been discussed in depth. What really stuck out was a comment from Glenn Brandt that their Wireline network would double in size, driving efficiencies for expenses and capital material. Critically, this is not counted in the synergy benefit.

Earnings Guidance Looks Great, Even Without Synergy

In the Q1 2023 earnings release , we looked at revised earnings guidance for 2023 for the combined companies, which I feel is impressive.

The combined company cash flow is C$2 billion, with only C$200 million of C$1 billion in synergies reflected. And management indicated in the earnings call that CapEx will be consistent going from 2023 to 2024. That makes the 2024/2025 cash flow close to C$3 billion, if not higher.

Management plans to deleverage; there is currently close to C$22 billion in long-term debt following the acquisition. Still, with dividend payouts of under C$800 million in the last few years, the company has plenty of headroom to return additional value to shareholders.

Market Keeps Ignoring Good News

I believe that Rogers Communications is undervalued with significant upside due to depressed valuation multiples and the market repeatedly ignoring good news.

P/E GAAP ((FWD)) is down 21.17% to the sector and 10.81% to the historical average. Additionally, EV/EBITDA ((FWD)) is down 4.63% to the sector and 8.25% to the historical average. In my opinion, this is a bright flashing indicator that the stock is undervalued. In the first quarter of the year , EBITDA increased 7% on revenue growth of 4%. Yes, a wireless telecom managed to grow EBITDA 3ppt faster than revenue. And keep in mind, this is pre-synergy. That does not seem like a stock that should have depressed ratios.

I also keep seeing the market skip over good news. At the time of publication, Rogers Communications is down 10% across the last year. When the long-awaited merger approval was announced on March 31st this year, the stock fell almost two dollars. When Q1 earnings were released, and the market got an initial view into the combined company, the stock only rose one dollar.

And just to cover all the bases, I believe the dividend is very safe at the current level of cash flow, and has the potential to grow as management deleverages. The most recent quant ratings agree, with even the low dividend yield score reflecting that management may look to increase yield in the future:

Downside Potential

There are a few concerns that Rogers Communications will have to overcome to deliver an upside on the stock price.

First, management must successfully integrate Shaw Communications into the business. Most importantly, they must deliver synergy benefits while maintaining the existing customer base.

Second, as of the Q1 2023 earnings , the Canadian telecom industry was not seeing recessionary impacts in the business. They delivered strong net adds and maintained ARPU. Given that telecom is seeing a slowdown across the US and EMEA , there is a risk of a slowdown in Canada. Fortunately, Canada does have a lower penetration than comparable countries, so there is still room to grow.

Lastly, the company needs to maintain 21 conditions as part of the merger approval , the most notable being the requirement that wireless prices come down. This is included in earnings guidance and can be driven by package deals and value carriers, so I am not overly concerned. Still, ARPU is something to watch as Rogers Communications works to meet the conditions.

Verdict

I rate this stock a buy and believe that investing in Rogers Communications at its current valuation presents investors with attractive upside potential over the next two years. Barring a significant economic impact on the Canadian telecom industry, management is poised to provide significant shareholder returns as C$1 billion in synergy value is recognized.

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