BCE Inc T.BCE.PR.K

Scotia comments on valuation

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Why BCE Might Not Raise the Dividend in 2025

OUR TAKE: Mixed. Up to now, consensus continues to imply a dividend raise in 2025; we think otherwise and have held this view since July. We believe the board could look to pause dividend growth and possibly implement a discounted DRIP since we do not see a clear path for the company to organically fund its dividend in the coming years (see Exhibit 1 for the dividend sustainability path). With a dividend yield of 8.4%, clearly the company is not getting the full benefit from its dividend already. We believe taking a stand to not financing the dividend with debt will demonstrate a commitment to a healthier balance sheet. We believe BCE remains a strong company that continues to generate positive economic value add but reducing reliance on debt to fund the dividend is a must given the continuing higher interest rate environment.

KEY POINTS

Investing in FTTH was the right strategy. Let’s be clear, we are not arguing that management should not have used the balance sheet to invest in FTTH. We believe that this investment has future proofed the company and even repositioned it for growth in the long term. However, during that investment period we believe the company should have chosen to curtail dividend growth so not to put additional pressure on the balance sheet. While we can’t change the past, looking into the future we believe realigning real FCFs and dividend distribution is essential and the faster this is done the better it will be in the long term.

Reported FCF should not be the bogey for dividend coverage. While we expect dividend coverage to reach 99% of reported FCF by 2026, down from 127% in 2024, even while assuming zero growth in the dividend, we don’t expect leverage to begin to decline organically until at least 2029 given the significant reliance by BCE on leases that do not go into the calculations of reported FCFs. Our estimates show that the dividend payout ratio in 2024 as a % of true economic FCF is hovering around 200%. Our FCF forecasts up to 2029 as shown in Exhibits 1 and 2 are assuming significant reductions in capex as well as some recovery in WC starting in 2026. We also imply that the divergence between reported FCF and true economic FCF returns to its normative level of $750-850M from the peak of $1B in 2023. Given those assumptions we only expect full coverage of the dividend by FCFs in the 2029-2030 period. Continuing to grow the dividend at 3% going forward will likely result in additional strain on the balance sheet as at that rate of growth we don’t see a path for coverage to decline below 100% of true economic FCF before 2033 on an organic basis.

What additional actions could management take to improve the payout ratio? The company could implement a discounted DRIP similar to what TELUS has done. While dilutive to shareholders, it could shorten the time to reach a more sustainable coverage at which point this could position the company to resume a 2-3% dividend growth model in 2027. Given the dilution from the DRIP we still think a 2 to 3 year dividend pause would be warranted at this stage. See Exhibits 3 and 4 for expected dividend coverage assuming a DRIP.

The sale of MLSE should not affect dividend decisions. We continue to believe that the sale of the company’s ownership in MLSE was the right move. The price received coupled with the retained broadcasting rights offer a very generous compensation. While BCE should clear around $4.1B after tax from the sale, potentially reducing leverage by around 0.3x, we don’t believe this should affect the board’s prerogative on dividend sustainability. Companies should not rely on non-core asset sales to pay for regular annual dividend increases. Dividend growth should be only tied to organic sustainable earnings growth net of capex.

Would the decision to halt growing the dividend hurt the stock? Initially it is possible that some retail investors decide to take some money off the table causing pressure on the stock. Let’s take AT&T (SO with a target price of US$24) as an example which took a much more drastic decision to cut the dividend in half in early 2022. Initially the stock underperformed vs US peers by 5-10% in the following 2-3 months; however, as investors became convinced about the underlying intent of the company to reestablish a stronger balance sheet the stock began to outperform peers by mid-year. In addition to other actions by management to reduce costs, we expect AT&T to be in a position to renew with dividend growth in 2025 after a 3-year hiatus.

Around every quarterly reporting period since the beginning of this year the chatter gets louder and louder on BCE with some investors taking bets that the company will cut the dividend. These voices will continue if a stronger stand is not taken to realign FCFs and dividend distribution especially as we expect the telecom sector in Canada to remain growth constrained in the coming period due to continued pricing pressure and potentially regulatory hurdles. While we are not advocating a dividend cut, we believe holding dividends steady and implementing a discounted DRIP for a couple of years might be a good course of action at this stage to safeguard against potentially more drastic actions down the road.