The outlook for Canadian telecoms

The Canadian telecommunications sector, having faced various challenges recently, presents a promising investment opportunity. 

Listen to the full podcast on Advisor To Go, powered by CIBC Asset Management.

According to Greg Zdzienicki, client portfolio manager with CIBC Asset Management, telecoms underperformed the last couple of years, given “they’ve received pressure from a combination of different reasons.”

One challenge has been the shifting interest rate environment. 

When the Bank of Canada began raising rates post-Covid, the spread between the Canada 10-year bond yield and telecom dividend yield declined, reaching a decade low in June 2022. The spread has since improved, to about 3.2% at the end of May, Zdzienicki said.

“We anticipate that interest rates will continue to be lowered in the second half of 2024, turning what has been a headwind into probably a positive tailwind for [telecoms] going forward,” he said.

The regulatory environment has also affected Canadian telecoms, evident from the lengthy approval process for the Rogers-Shaw merger. Zdzienicki noted that the 2023 merger approval came with conditions, including Rogers’ divestment of Freedom Mobile, which was sold to Quebecor.

“The introduction of a fourth national player [Quebecor] would allow the government to deliver on a promise of reducing wireless pricing in Canada,” Zdzienicki said.

The added competition was a factor in the sector’s underperformance, he said, and competition has spilled over into the wireline market.

Regardless, “The industry has experienced these periods of heightened competition in the past, and, over time, market share and pricing trends tend to become a little bit more rational,” he said.

Looking ahead, Zdzienicki was positive on the sector, which “remains one of the pillars of Canadian infrastructure, with only four major players servicing the entire country.”

The sector is trading below historical multiples while paying an average yield of 6.7%, he said.

“At the current valuation, the industry is reflecting some fairly pessimistic viewpoints, and I think it represents an opportunity to buy some quality dividend-paying companies at attractive prices,” he said.

Zdzienicki was confident that telecoms can sustain their dividends, despite such factors as higher interest expenses.

“We still believe that companies will continue to service their dividend commitments going forward, with certain companies even continuing to grow their dividends annually,” he said. He referenced his second-quarter management meetings, in which executives reiterated their plans to continue paying dividends.

At the same time, “we do see a prolonged payout ratio of above 100% to be unsustainable,” he said. “We should see the overall sector payout ratios start to come down sometime towards the end of this year.”

Companies can sell non-core assets and cut costs to increase their free cash flow and reduce payout ratios, he noted, referencing Bell Canada’s recent divestiture of Northwestel.

Lastly, Zdzienicki compared Canadian versus U.S. telecom valuations. “The premium valuation of the Canadian telecom group relative to the U.S. peers has really compressed to about the lowest levels we’ve seen over the past 10 years,” he said.

However, while the U.S. market is structurally more competitive, the Canadian market faces what Zdzienicki described as “temporary” competitive pressures.

Also, “the population growth and the further penetration potential of the Canadian wireless market puts the Canadian [telecom] group in … an enviable position relative to the more mature U.S. market.”

This article is part of the Advisor To Go program, powered by CIBC Asset Management. It was written without input from the sponsor.