Canaccord Details Canadian telecommunications companies have reached an “inflection point” in the battle for dominance in the wireless market after a “rough” two-year stretch, according to Canaccord Genuity analyst Aravinda Galappatthige.
“In 2020, total returns in Telecom posted negative 5 per cent (including dividends) while the market cap weighted price declines were 10 per cent in comparison to a gain of 2 per cent for the S&P/TSX. This was the second successive year the sector underperformed the index, and materially so (2019 was over 900 basis points),” he said.
“The underperformance was largely due to a) continued weakness in wireless, with the pandemic adding incremental pressure, leading to greater downward earnings revisions than the Street would have originally expected and b) a shift in investor preferences toward growth-oriented stocks and sectors.”
In a research report released Wednesday previewing 2021 in the sector, Mr. Galappatthige said he thinks “we may be bottoming out as far as incumbent wireless fortunes go” and suggests investors adjust accordingly.
“In our view, the recent pressure on the sector was owing to a combination of factors, namely a) government and regulatory b) the financial J-curve triggered by the introduction of unlimited c) elevated competitive intensity which has driven down pricing (and the value of data), and d) the downturn in roaming and data overage owing to the pandemic,” he said.
“There are tangible signs of an inflection point in all four of these pressure points. For instance, on the regulatory/government side, there are indications that there may be a general change of heart, demonstrated by ISED’s intervention on the TPIA matter and related comments from the Minister that suggests the government is reverting its focus back on the significance of investment. This has implications for the MVNO file. On competitive intensity, there is good initial evidence that the surge in promotional activity during the BTS season is behind us, with all CEOs (incumbent and regional) railing against price irrationality and the subsequent ‘relative’ easing in such activity during Black Friday and Boxing day. We believe that this together with some useful cost reduction opportunities in the space and a likely uptick in investor focus on 5G toward the end of 2021, argues for a tilt back toward wireless.”
Based on that view, Mr. Galappatthige said he’s taken an old, theme-based stock selection approach.
“In our 2018 Playbook, we demonstrated (with data going back to 2007) that a useful approach to picking the potential outperformers in this sector was to start with a thematic angle before layering on stock level considerations,” he said. “One of the basic elements of this approach was classifying the upcoming period (normally 18-24 month periods) as pro-wireless or negative on wireless, which empirically largely explained relative performance. Three years on, we are in a position to further nourish this theory and provide an updated version of the ‘back-test’, which we found continues to hold up well.”
“Our view on wireless together with the aforesaid approach points us in the direction of Rogers followed by TELUS for 2021. In the case of Rogers, history suggests that it is the ‘high beta play’ in wireless. Several other factors - valuation, post-pandemic rebound, lapping overage declines, traction in cost reduction, etc., support our call.”
That led Mr. Galappatthige to upgrade Telus Corp. to “buy” from “hold” with a $27 target, up from $24. The average on the Street is $27.30.
“TELUS has adopted a notably differentiated strategy from its Telecom peers by committing resources to its TELUS International and Telehealth divisions; a strategy which is starting to look better and better with the acceleration in growth in digital health and expansion in opportunities for business services,” he said. “More recently TELUS has expedited the push to build out these divisions and diversify its business, mainly through M&A and is signally its intentions of driving forward its 3rd leg of growth in the form of Ag-Tech. From this standpoint, in a Telecom industry whose growth prospects are certainly moderating, TELUS is arguably the stock to own from a longer-term basis. Add to this the relative strength in its wireless performance and disproportionate gains in wireline sub additions share, we have a compelling thesis.”