Telecom dividends keep on growing

But Moody’s warns that the strategy might not pay off in the long run

Canada’s telecommunications sector continues to raise dividends at a torrid pace in a bid to attract yieldhungry investors, but further payout increases might not be sustainable in the long run, warns Moody’s Investors Service in a new report.

“In this environment, there is significant pressure on these companies to increase their dividends in order to continue to drive shareprice appreciation,” said Bill Wolfe, a senior vice-president at the ratings agency.

As a result, he said, the share prices of Canadian broadband communication companies such as BCE Inc., Rogers Communications Inc. and Telus Corp. have become “relatively more bond-like with increased sensitivity to dividend yield and decreased sensitivity to earnings.”

At the same time, enterprise valuation and price/earnings multiples for these companies have accelerated, even as the sector has matured and its growth prospects have declined.

“Share-price appreciation has reduced some companies’ dividend yields, despite aggressive dividend increases,” he said. “But with bond yields having fallen by even greater amounts, the difference between dividend and bond yields has increased over the past four years.”

Wolfe is worried that pressures to continue increasing dividends will eventually impact the credit quality of the country’s telecoms because sector growth is slowing due to increased competition.

Many companies are promising dividend growth of 5 per cent to 10 per cent, but he believes that is unsustainable based on his prediction of three per cent EBITDA growth for the group over the next few years. “Despite this, many companies promise an extended period of outsized dividend growth, describing their businesses as ‘dividend growth models,’” he said.

Greg Newman, associate portfolio manager at The Newman Group, a division of Scotia McLeod in Toronto, is also concerned about the future dividend growth of the country’s telecom companies.

He said the fundamentals of BCE, Telus and Rogers have driven free cash flow higher over the past six years or so, but the companies have grown their dividends even faster.

“As a result, payout ratios have been on balance creeping higher,” he said. “Absent another source of growth, either organic or by acquisition, the dividend growth that we have seen thus far will eventually likely have to slow.”

But Barry Schwartz, chief investment officer at Baskin Wealth Management in Toronto, is confident that better free cash flow is ahead for the telecom group.

“Bell and Rogers have spent fortunes over the past few years and have leveraged their balance sheets,” he said. “I think that is coming to an end and you may see a renewed focus on reducing debt.”

Whether or not these companies can grow and maintain the pace of dividend increases will come down to which of them executes best in an increasingly competitive landscape, said Jerry Olynuk, portfolio manager at Northland Wealth Management in Calgary.

He said Telus is “in the sweet spot” right now as it has been able to increase its average revenue per unit and customer retention rate while completing a major capital expenditure into media.

Cogeco Inc., meanwhile, has a lower-than-average dividend yield, he added, and is benefiting from both a currency tailwind on its U.S. revenues and its “remarkable restraint” regarding leverage despite an ongoing acquisition strategy.

“In addition, it is worth noting that the sector as a whole, and these companies in particular, offer a far lower volatility rating than the overall market for investors who are looking for capital preservation in addition to an appealing dividend yield,” Olynuk said.

Share-price appreciation has reduced some companies’ dividend yields, despite aggressive dividend increases.