The Case For Canadian Telecom

By Investopedia Staff | August 11, 2009 AAA

Investors and analysts alike are all wondering whether the spring and summer rally the equity markets have experienced this year is finally coming to an end. With the S&P 500 back up over 1,000 and the Dow Jones Industrial Average well over 9,000, it looks like profit taking and a market pullback may be inevitable. That being said, I still believe that there are many options out there for investors looking for upside potential in a market that may be ready to correct some of the big gains we've seen lately. One sector that I firmly believe should be able to outperform other sectors while providing great yields at the same time is Canadian telecom.

The Canadian telecom sector has not performed nearly as well as the overall Canadian equities market in 2009; the S&P/TSX Composite Index is up 20% year-to-date and over 40% since early March, while the telecom sector is down 5% for the year and is the only sector to post negative returns on the TSX for 2009. With negative returns during one of the biggest rallies in history, it may sound a little counterintuitive to consider Canadian telecom a profitable sector going forward. The primary reason for my bullish stance on the sector is the defensive nature of Canadian telecom stocks. In the past, the late summer months and early fall has been considered a seasonal weak time for cyclicals, so holding up these defensive stocks would be a smart choice given the uncertainty going forward.

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Ring the Bell
The biggest player in Canadian telecom by market cap is Bell Canada Enterprises (NYSE:BCE). BCE has fared better than its sector as a whole, rising 14% in 2009. Although BCE missed analyst estimates by a penny last quarter, the results still topped earnings from the same quarter last year by 9%. The company also announced an increase of 5% to its dividend, raising the annual payout to C$1.62, a yield of 6.3%. Even in a volatile marketplace, the dividend yield alone is a great reason to get into this stock.

BCE has also found love with many analysts, with a consensus buy rating earmarked to outperform the sector. Currently sitting at $23.50, a move up to the $28 to $30 range is not out of the question. Shares also rose slightly on Wednesday following an analyst report stating that BCE and rival Telus (NYSE:TU) would merge within two years. The analyst cited increased competition in the Canadian wireless sector and the need to cut costs as the primary argument for a merger between the two competitors.

Telus More
Speaking of Telus, Canada's second-largest phone company has been in cost-cutting mode for the greater part of 2009, already downsizing staff by 1,500. But while it's pinching pennies in some aspects of its operations, Telus increased capital spending by 28% in the second quarter, gearing up to introduce high-defintion television service to its land-line subscribers. Although a boost in capital spending may not be a great move for the balance sheet in the short term, it gives Telus the ability to compete in the television service industry; competitors include the aforementioned BCE, Shaw (NYSE:SJR) and Rogers Communications (NYSE:RCI).

That same earnings announcement reported a 9% drop in profits, due primarily to to a drop in wireless revenues, even though Telus' revenue from wireless data jumped an astonishing 37%. While the earnings numbers gave investors and shareholders mixed messages, the company's dividend is still the primary reason to get into this stock. At 5.9%, any sort of capital gain from the shares will be icing on the cake for investors seeking out defensive positions.

Roger That
BCE and Telus' biggest competitor in the Canadian market is Rogers Communications. Rogers is currently the only wireless provider of the "Big 3" that uses the GSM standard for its wireless devices, a move that has paid big dividends thus far. Due to compatibility issues with the Bell and Telus networks, the ever-popular Apple (Nasdaq:AAPL) iPhone has only been available to Canadian customers via Rogers. That, along with sales from a multitude of other smartphones only compatible with GSM, allowed Rogers to generate second-quarter earnings 24% higher than in 2008 and EPS of 65 cents, handily beating analyst estimates of 55 cents. Even with the increased sales numbers and effective cost-cutting measures implimented by Rogers, shares have still done very little. The stock is up only 3% in the past three months and down a surprising 9% so far this year.

Although some analysts have downgraded the stock to "market perform", I still see plenty of upside with Rogers. Its long-term growth prospects compared to its competitors look strong, and it has proved its ability to produce free cash flow and create shareholder value. I think a price target of $31 on the stock for the end of 2009 is not unreasonalbe. And although Rogers' yield is not in the same ballpark as its competitors, the company's current dividend yield of 3.9% is a strong argument for dividend investors looking for upside.

Bottom Line
The Canadaian telecom sector provides a defensive play for investors who are worried about where the markets are headed in the second half of 2009. Canadian telecoms are providing great yields and strong growth potential, so look north for a telecommunications safe-haven. (To learn more, read Dividend Facts You May Not Know.)

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