“Ringing” Up Value and Dividends

04/30/2013 7:45 am EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters of Morningstar DividendInvestor thinks consolidation in the Canadian telecom industry will “ring up” profits for this company.

With a nice yield, good dividend growth, and an improving competitive outlook, Rogers Communications (RCI) has become a leading candidate for our Builder Portfolio.

The Canadian telecom industry benefits from relatively low mobile penetration rates, a generally rational competitive environment, and strong operational efficiency.

Rogers, which is our favorite firm in the industry, generates most (58%) of its revenue from wireless service—the highest proportion of the three mobile incumbents (the others being Telus (TU) and BCE (BCE)). Rogers boasts the most reliable network in Canada and a superior spectrum position (roughly double that of Telus). By leading its rivals in terms of postpaid mobile subscribers and points of presence, it boasts an entrenched position among the Big Three.

Rogers is also a solid cable operator, with about 60% of the households in its territory taking television service (less than 45% penetration is typical in the United States) and providing a superior platform to the phone networks with which it competes. Attractive media assets round out Rogers’ portfolio.

The Canadian wireless industry has become increasingly polarized of late, with the Big Three losing the near-term margin battle, as the scrappy new entrants continue to pressure acquisition and retention costs. We saw a somewhat similar scenario play out in this sector roughly a decade ago, when Clearnet and Microcell ran their unprofitable mobile operations into the ground and sold out to Telus and Rogers, respectively.

But Clearnet and Microcell were in a far better position than today’s crop of startups before they crashed and burned, and we don’t think it will be long before the new entrants are forced to consolidate to stay afloat. Eventually, we see them falling into the hands of the Big Three, which will be permitted in the second half of 2013.

Rogers continues to be in very solid financial shape and has investment-grade credit ratings, including our rating of A-. The company devotes about half of its earnings and free cash flow to dividends, supplemented by significant share repurchases. Given the stability of its cash flow and healthy competitive position, we find Rogers’ dividend well supported.

Before Ted Rogers passed away in late 2008, the firm was known for a bold and aggressive acquisition and investment strategy. Under current CEO Nadir Mohamed, the focus has shifted more toward capital discipline, cost-cutting, and shareholder returns.

The quarterly dividend (which is paid in Canadian dollars) rose from $0.125 a share at the end of 2007 to $0.395 a share during 2012, and an additional 10% increase to $0.435 a share is in place for 2013.

Though Mohamed will retire at the end of 2013, we expect current policies to continue. We expect sales to continue rising at 3%-4% annually, a moderate amount of operating margin expansion once the competitive environment consolidates, and continued buybacks to drive future dividend increases averaging 7%-10% annually over the next three to five years.

With the stock recently trading at a 20% discount to our $60 fair value estimate (and well below our $54 Dividend Buy price), resulting in a 3.5% current yield, we think Rogers is poised to provide long-run total returns averaging 10%-12% annually.

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