The Siren Call of a Big Dividend

06/26/2013 10:15 am EST


John Heinzl

Reporter and Columnist,

This Canadian regional telecom operator has both challenges and opportunities ahead. Here's what investors should know, writes John Heinzl of Globe Investor.

Telecom stocks are prized for their juicy dividends, and Bell Aliant's (Toronto: BA) nearly 7% yield is the juiciest of them all. But is it safe?

When a yield gets that high, there's usually a reason, and in Bell Aliant's case there are a few. Today, in response to some reader e-mails, we'll explore the challenges-and opportunities-facing the company, so that investors tempted by the outsized yield know what they're getting into.

Less Wireless
Halifax-based Bell Aliant provides telephone, Internet, and TV services to more than 5 million customers in Atlantic Canada and rural areas of Ontario and Quebec.

Unlike BCE (BCE), Telus (Toronto: T), and Rogers (ROG), however, Bell Aliant has very limited wireless exposure. It operates wireless networks in Quebec and Northern Ontario, but elsewhere it serves as a reseller for Bell Mobility (whose parent BCE owns about 43% of Bell Aliant).

That's a strike against the company, given that wireless revenues are a key driver of growth in the communications sector.

More Fibre
Lacking a major wireless presence, Bell Aliant is focused on rolling out FibreOP, a high-speed fiber-optic network for voice, Internet, and TV services. This is an expensive proposition, but it's also Bell Aliant's best hope for generating much-needed growth as its legacy landline business declines.

The results so far have been encouraging. At the end of the first quarter, FibreOP's coverage area extended to 679,000 homes, with a goal to reach 800,000 by the end of the year.

Of the homes that can access the service, about 19% have signed up for Internet and 17% for TV, with substantial numbers getting both, said Dvai Ghose, an analyst with Canaccord Genuity.

TV is a low-margin product because revenue is shared with programmers, but Bell Aliant is using TV to attract customers to its higher-margin Internet service—a strategy that bodes well for the long term.

"The Internet pipe is the only important pipe of the future, because your voice, video, and data will all be on that pipe," said Ghose, who adds that Bell Aliant's fiber rollout has been the most aggressive of any company in Canada.

For its part, Bell Aliant sees plenty of opportunity to add more customers in existing FibreOP territories.

"Some of our most mature FibreOP markets are approaching penetration rates in the high 30% ranges. So we have lots of room to increase our penetration numbers in the footprint we already have available, and as we build more footprint, that will give us even more loading opportunity," Bell Aliant CEO Karen Sheriff said on the first-quarter conference call in May.

FibreOP is already bearing fruit. In the first quarter, Bell Aliant's total revenue rose 0.3%—the best performance since the second quarter of 2008. Helped by cost controls, earnings before interest, taxes, depreciation, and amortization (EBITDA) rose 0.7% excluding a one-time regulatory charge—also the best showing in years.

About That Dividend
That's not to say Bell Aliant has smooth sailing ahead. The former income trust is facing a big jump in cash taxes that will drive free cash flow per share down to an estimated range of $1.54 to $1.58 in 2014—not enough to cover the $1.90 a share dividend, Ghose said.

However, the company has options to avoid a dividend cut, he said. These include slightly increasing debt levels or slowing the fiber-to-the-home expansion to free up more cash.

Another option is for the company to offer a discount on its dividend reinvestment plan to entice more investors to enroll, Neeraj Monga, an analyst with Veritas Investment Research, said in a note. That would help the company conserve cash, because more investors would be getting paid in shares instead.

"In our opinion, a dividend cut would be the absolute last resort after other cash-management initiatives are implemented," wrote Monga, who views the dividend as "safe for at least the next 18 to 24 months" and has a "buy" rating on the shares.

Sheriff said on the call that the company is "not at all concerned about our dividend," even though some US hedge funds have reportedly shorted the stock, based in part on expectations of a potential dividend cut in 2014.

Opinion Is Divided
Of the 15 analysts who follow the company, four have "buy" recommendations, with nine "holds" and two "sells." The average target price is $26.83—below Tuesday's close of $27.45—indicating that many analysts feel the shares are fully valued or slightly overvalued.

Ghose, who has a "hold" rating, said he's cautious because the stock could pull back if interest rates rise. He would be more interested at $25, because there would be a greater chance for capital gains.

Bell Aliant will have to demonstrate "significant and sustained EBITDA growth before we see significant stock price appreciation," he said.

But there's another wild card to consider: BCE could make a bid to take Bell Aliant private. There's long been speculation about such a deal, and "it's definitely a possibility under the right conditions," Ghose said.

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