By Jamie Sturgeon | Vancouver Sun | July 25, 2010With the economy sending mixed signals, markets have been dicey for months. But there have been pockets of calm, and in particular Canada’s telecom sector, which has enjoyed steady gains against the S&P Canadian benchmark index in 2010.
Investors should not be surprised. For years now, wireless profits have fuelled enviable cash flows and solid earnings growth at Rogers Communications Inc., BCE Inc. and Telus Corp. In recent quarters, each firm has diligently spun out more and more cash to stockholders in the form of dividend hikes while Rogers and Bell have been busy buying back shares, making owning one if not all three a must for value seekers.
As Rogers kicks off second-quarter earnings season this week, the good times are expected to continue. “It will be relatively consistent for the big three,” Phillip Huang, analyst at UBS says, echoing the consensus view on Bay Street.
But good times have a history of ending and some, including Mr. Huang, believe the horizon on the sector’s safe-haven status appears fast-approaching.
“I would characterize it as the calm before the storm, especially if you’re looking at the wireless side,” he said.
The reason for the growing pessimism stems from fresh competition from stalwart cable firms now arming themselves with wireless, and cellphone startups that have recently entered market. Both forces threaten to dent the sector’s impressive cash-generating powers in the second half of the year, some say, and beyond.
On Tuesday, Bay Street expects Rogers to report earnings of 67¢ a share on revenues of $3.026-billion. One focus will be on wireless profit margins, which are expected to continue to fatten. Rogers has been the most aggressive of the big three telecoms in marketing smartphones to existing subscribers and new customers. It was the exclusive Canadian provider of the iPhone up until last November, and as more subsidy costs on expensive handsets are made back, margins are expected to rise among those users, which accounted for a third of its eight-million-plus base in the first quarter.
Many expect that higher mobile data revenues will help Rogers sail past Street estimates and adjust its outlook higher.
“Based on stronger wireless margins, we believe RCI will tweak and raise 2010 guidance this quarter,” Jonathan Allen of RBC Capital Markets wrote in July 7 note.
But margin gains reflects slowing growth. Wireless margins are rising because the amount Rogers is spending to subsidize new smartphones is decreasing as fewer new customers are signed up. New competition from the likes of Wind Mobile may be having some effect in core marketssuch as the Greater Toronto Area. But BCE’s Bell Mobility, once the third-place runner in wireless, is likely the greater concern for Rogers.
Bell has been steadily gaining ground since activating its new wireless network last fall, and is again expected to show robust customer additions when it reports on Aug. 5. A marketing barrage led by its sponsorship of the Vancouver Winter Games led to a blockbuster first quarter. Wireless additions are expected to moderate, but Bell may still add as many as 100,000 new subscribers in the spring compared to 90,000 at Rogers.
“Bell will again win market share away from Rogers. New entrants, as well, but to a lesser extent,” Dvai Ghose at Canaccord Genuity said.
The downside is that Bell faces a period of cost pressures as subsidies for iPhones and BlackBerries will be heftier than peers. But Bay Street expects Bell to report profit of 73¢ a share and revenue of $3.78-billon. Another 5% hike to the dividend to $1.83 is almost a lock, following a 7% hike at the end of 2009.
The leveling playing field in wireless between Bell and Rogers also sets the stage for a fierce battle for television subscribers once Bell introduces its new IP television product in Toronto and other markets this year.
As for Telus, the market will be watching whether a very promising start to the year can be maintained when it reports on Aug. 6. RBC’s Mr. Allen called Telus’s first-quarter performance a “turning point” as it recovered from a bruising 2009 which saw wireless revenues per subscriber fall the sharpest among the big firms, and intense competition from Western Canada cable giant Shaw Communications Inc. accelerate home-phone customer losses.
“Telus was arguably the hardest hit by the economy and competition last year,” Mr. Allen said.
But now Telus is hitting back. An aggressive roll out of its rival IP-based television and Internet product bundle, called Optik, is seeing gains against Shaw, and the benefits of cost-cutting efforts have started to pay off. The Street expects the Vancouver-based firm to report 76¢ a share in profit on $2.42-billion revenue and a performance in line with the high end of its full-year guidance.
Telus shares have climbed the highest among the big three this year, appreciating more than 20%, compared to gains of 9% and 13% for Bell and Rogers, respectively.
Average monthly revenues collected per subscriber (ARPU) are also expected show stabilization. Competitive pressures and lower overall usage because of a dismal economy saw voice fees cut last year and data usage fail to make up the difference.
“Declines are going to be much more modest this quarter than what we’ve seen,” Canaccord’s Mr. Ghose said.
Greg MacDonald of National Bank Financial said the quarter will show that wireless data revenues are beginning to buoy and even lift overall ARPU levels at the big three, even as they continue to lower pricing on mobile call charges due to new competition. “I’m looking for flat blended ARPU because of the data growth you’re seeing, despite high single digit erosion on voice,” he said.
Picking a winner among Rogers, Bell and Telus for the quarter can be debated. Investors have flocked to all three this year to take advantage of healthy dividend payouts that are second-best among Canadian stocks as a group (5.5% on average vs. 5.6% among utilities), and have steadily risen.
“All three have done really well,” Juliette John, portfolio manager for Bissett Investment Management’s dividend funds. She manages $750-million, of which 12% is spread across the three telecoms. “They’re considered a bit more conservative and that has become much appreciated I think. And of course that yield is really attractive.”
What cannot be argued is that they all face intensifying competitive pressure going forward, with no consensus on what the impact will be. “If equity markets remain volatile, then a position in telecom for another couple of months may still be attractive,” Mr. Allen said. “But we recommend that investors consider trimming positions as the year progresses.”
Rogers announced at the end of June it would launch “chatr”, and new discount brand to rival offerings from Wind and other upstarts Public Mobile and Mobilicity, which began offering services in key markets in May. Chatr would also preempt a wireless launch from Quebec cable power Videotron Ltee. this summer, and Shaw next year.
The fear is that the move will provoke aggressive responses from Bell and Telus, and perhaps trigger a price war, dragging down profits across the $16-billion sector.
“I’m not so much concerned about the standalone new entrants, even Videotron and Shaw,” UBS’s Mr. Huang said. “The real worry is about what the incumbents do to themselves.”
Canada’s wireless market is maturing and as the race for the last subscribers ensues, margins and revenues may be sacrificed to guard and gain share. Marketing costs are expected to soar in the current quarter.
Some, like Canaccord’s Mr. Ghose say the competition is having a greater effect than is realized. “I believe the new entrants have taken more share than what equity markets think,” he said.
Still, all three have the wherewithal to continue raising dividends and buying back shares. Dips in valuation in the coming months can even provide buying opportunities, Bissett’s Ms. John said.
“New entrants could create hiccups, but that could serve as buying opportunities,” she says, “depending on how aggressive all of the players become.”
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