3 Canadian telecom stocks that are currently undervalued and have potential for growth

The Bank of Canada’s second consecutive interest rate cut seems to have set the table for additional moves to lower interest rates in the months ahead. For investors, this could present opportunities among the stocks of companies that have faced headwinds from higher interest rates over the last two years. Lower overnight rates have significant implications for several sectors of the Canadian economy, including telecommunications.

Telecom companies are capital-intensive, requiring substantial investments in infrastructure like towers, fiber optics, and 5G networks. Reduced borrowing costs make it cheaper for these companies to fund their capital expenditures and expansion plans. Additionally, lower rates reduce the cost of servicing their significant debt obligations.

Opportunistic long-term investors may want to consider the leading Canadian telecom players, which control 90% of the domestic market. These operators stand out for their consistent dividend payouts, robust cash flow, and potential for price appreciation. In addition, Morningstar analysts consider all three to be significantly undervalued.

Here’s a close look at three undervalued telecom stocks that could benefit from lower interest rates.

Rogers Communications RCI.B

Analyst: Matthew Dolgin, CFA

The largest wireless service provider in Canada, Rogers Communications boasts more than 11 million subscribers, or a third of the domestic market. Wireless business accounts for more than half of total revenue, while its cable segment (which recently acquired rival Shaw) provides about 35% of total revenue. Rogers’ media unit, which comprises television and radio stations and the Toronto Blue Jays, bring in the rest of its revenue.

Rogers paid a total of $2 billion in interest on borrowings in 2023, up from $1.3 billion in 2022, marking a 46% increase. This rise was primarily due to higher interest rates. The company counts higher interest rates as one of key financial risks, as changes in interest rates can significantly impact their interest expenses on short-term borrowings and credit facilities.

On the business front, the national telecom provider is well-positioned to retain its market dominance. As a result of heavy investment in its wireless network expansion over the past few years, “Rogers has had the strongest wireless business in Canada, and we don’t expect it to lose ground,” says a Morningstar equity research report.

The operator reported a significant earnings increase in the past quarter, driven by last year’s acquisition of rival Shaw Telecommunications and a surge in wireless subscribers. 

In its cable business—which offers home internet, television, and landline phone service to consumers and businesses—Rogers is locked in an intense battle for market share with rival telecom giant Bell. “We don’t think Rogers’ network is inferior in any geography, but it is simply facing competition that is of a higher quality than it had historically, when Rogers had the clearly superior network,” asserts Morningstar equity analyst Samuel Siampaus. He puts the stock’s fair value at C$78 per share and forecasts wireless to be the biggest driver of Rogers’ sales growth.

BCE BCE

Analyst: Matthew Dolgin, CFA

BCE is one of the big three national wireless carriers, providing wireless, broadband, television, and landline phone services to over 10 million customers, constituting about 30% of the market. Like its closest rival, Rogers, BCE has a media segment that consists of television, radio, and digital media assets. BCE licenses the Canadian rights to movie channels including HBO, Showtime, and Starz.

In 2023, BCE paid $329 million more in interest expenses compared with 2022, primarily due to higher debt levels and increased interest rates. Low interest rates would help BCE save money on interest payments, which strengthens its financial position.

After several years of upgrading its wireline network with fiber, BCE is leading its competitors in acquiring new broadband subscribers. “We expect the firm to continue taking share, but we expect the pace to ease, as the firm has slowed its fiber network buildout,” says a Morningstar equity report.

Despite the slowdown, BCE is enhancing its broadband internet services in areas where it is expanding its fiber network. This creates fresh opportunities to gain new subscribers who have so far had to contend with limited (or a lack of) alternatives.

BCE remains a leading wireless service provider throughout Canada, dominating an oligopolistic market alongside Rogers and Telus. However, “we expect the wireless market to become even more competitive as Quebecor expands its footprint nationwide after historically operating only in Quebec,” cautions Morningstar equity analyst Matthew Dolgin. He puts the stock’s fair value at C$60 and projects a 2% annual revenue growth.

Telus T

Analyst: Matthew Dolgin, CFA

Telus is one of the Big Three wireless service providers in Canada, with about 30% of the total market share. It has the most dominant position in British Columbia and Alberta, where it provides internet, television, and landline phone services. As a result of recent acquisitions, over 20% of Telus’ sales now come from non-telecom businesses, most notably in the international business services, health, security, and agriculture industries.

In 2023, Telus’ interest expense rose to $336 million in the fourth quarter (an increase of $71 million), due to higher interest rates and increased long-term debt. Moreover, the softening real estate market, caused by rising interest rates, has negatively impacted demand for Telus’ services.

The wireline unit remains the crown jewel of Telus’ overall business, and it has significantly upgraded its broadband services there by switching out its legacy copper network for fiber. “This move has set Telus up for a prolonged period of success,” says a Morningstar equity report. Notably, Telus has already captured a significant portion of the market from its primary competitor, Shaw (now owned by Rogers), in western Canada. In addition to gaining more subscribers, the better capability of the fiber network “gives Telus more pricing power and is more efficient, leading to reduced costs,” says Dolgin. He puts the stock’s fair value at $33, and forecasts its operating revenue to grow by about 4% in 2024.

Telus’ wireless segment will remain robust and is expected to “benefit from subscriber growth throughout the industry,” he adds. However, he notes that while Telus’ network strength will help it keep pace with peers, intense competition will crimp both it and its rivals’ pricing power.

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