Industry Note Equity Research July 27, 2016

Transcription

1 Industry Note Equity Research July 27, 2016 Communications Lower Rates Equal Multiple Expansion for High-yielding Telcos Impact: SLIGHTLY POSITIVE TD Investment Conclusion We are increasing our target prices for Rogers, TELUS, and Shaw based on our view that the persistently low interest rate environment is changing the way that Canadian investors perceive and value these stocks. We have always loosely factored the interest rate environment into our assigned target multiples for these stocks, but as of today, we are formally factoring into our valuations the difference between the long-term (15-year) historical average yield for the GoC 10-year bond (3.4%) and the current TD Economics forecast one year out (1.4%). As long as the rates remain at historical lows, we believe that these large-cap stocks, with relatively stable cash flows and dividend yields of over 3%, are likely to continue to trade at valuation multiples that are arguably excessive versus either fundamental growth prospects or historical averages. A summary of the changes to our target prices is presented in Exhibit 1 (note that there are no rating changes), and a brief description of what we have done by company is shown on the next page. Vince Valentini, CFA vince.valentini@tdsecurities.com Bentley Cross, CFA bentley.cross@tdsecurities.com Brandon Smith, CFA, (Associate) brandon.smith@tdsecurities.com Beware of the Risk of Rising Rates The trend in rates recently has been the friend of telecom investors, but there could be risk in the future if one shares our view that valuations have become more correlated with rates. The good news about cable/telco cash flows is that they are largely immune to economic cycles, which tends to command a premium from investors who are looking for stability and safety. The bad news is that these cash flows are unlikely to experience much cyclical growth if the improved economic conditions cause an increase in interest rates over time. In other words, there is not much of a hedge in place to protect these names from rising rates. Using our current valuation methodology (70% of the change in rates being added or subtracted to our base-case multiples in a normalized rate environment), we show in Exhibit 2 how much downside there could be to our target prices if the rates head back towards 2-3% in the future. Exhibit 1. Summary of Target Changes Rating Current Share Price Forecast Dividend New Target Price Old Target Price Forecast Return Rogers BUY $57.44 $1.97 $64.00 $ % TELUS HOLD $44.01 $1.84 $46.00 $ % Shaw BUY $26.34 $1.19 $31.00 $ % Source: TD Securities estimates Please see the final pages of this document for important disclosure information. Page 1 of 7

2 Rogers: Our target price increases to $64.00 from $62.00, and we note that we had already increased our target multiples on an interim basis when the company reported Q2/16 results last week. We now use 8.9x 2017E EBITDA for wireless (up from 8.75x) and 7.9x 2017E EBITDA for cable/media (up from 7.5x). In a normalized interest rate environment, we would peg the valuation of Canadian wireless assets at 7.5x EBITDA based on: a) FCF growth prospects; b) peer comparisons; and c) historical multiple ranges. A similar analysis for cable assets would get us to a normalized target multiple of 6.5x EBITDA. We then inflate both these multiples by 70% of the difference between the current interest rate forecast (1.4%) and the normalized long-term rate (3.4%). Therefore, for wireless, we take 3.4 minus 1.4 equals 2.0, then multiply by 0.7 to get 1.4, and then we add this to 7.5x to get a target multiple of 8.9x. We have back-tested the relationship between valuation multiples and interest rates over the past 10 years (with more emphasis on the data from 2010 to today, subsequent to the financial crisis, which is shown in Exhibit 3, as that is when the correlations between rates and telco multiples increased) in order to conclude that 70% of the change in rates is a reasonable assumption. TELUS: Our target price increases to $46.00 from $ Similar to Rogers we now use 8.9x for wireless (up from 8.5x). For wireline at TELUS, we are now using 7.4x 2017E EBITDA (up from 7.0x), with our base multiple (preadjustment for rates) of 6.0x being below that of Rogers/Shaw cable at 6.5x owing to both the lack of FCF from this segment at TELUS and our view that the cablecos enjoy superior broadband economics (no need for hefty FTTH capex to deliver 1 Gbps). Shaw: Our target price increases to $31.00 from $ Similar to Rogers, we now use 7.9x for cable (up from 7.25x). For the business telecom and data centre operations, we continue to use 9.5x 2017E EBITDA as these higher growth segments generate less FCF today and therefore we do not believe that more of a premium for low interest rates is justified. There is also no change in our DCF-based valuation for WIND as we do not want to change the terminal value assumptions in 2022 based on the interest rate environment today. Also note that about $1.00 of the increase in our target price for Shaw relates to an error in our model where we had doublecounted $400 million of spectrum purchases within our debt forecast. Other cable/telco names: Given that we are restricted on BCE and MTS, the only two cable/telco stocks under coverage that are not being affected by our valuation changes today are Quebecor and Cogeco. In both cases, we believe that the dividend yields and liquidity are too low for investors to use these stocks as alternatives to bonds in their portfolio; as such, we cannot justify a more direct linkage between interest rates and our target prices at this time. If these companies implement much higher dividends in the future, then we might reconsider our view. Alternatively, if larger-cap comps consistently trade at higher multiples (in part because of low rates), then there could be an upward bias to our target multiples over time even if dividend yields remain relatively low. Page 2 of 7

3 Exhibit 2. Target Price Sensitivity to 10-year GOC Rate Current Implied Targets at Different Rates Target* 2.0% 3.0% 4.0% Rogers $64.00 $60.00 $53.00 $46.00 TELUS $46.00 $43.00 $37.00 $31.00 Shaw $31.00 $29.00 $27.00 $24.00 * Ascribed multiples based on forecast 10yr GOC rate of 1.40% Source: TD Securities Inc. estimates Exhibit 3. Historical EV/EBITDA Multiples across 10-year GOC Rate Buckets 10yr GOC Range Source: TD Securities Inc. Average Low* High** Data Points 0.5% to 1% % to 1.5% % to 2% % to 2.5% % to 3% % to 3.5% % to 4% yr GOC Range Average Low* High** Data Points 0.5% to 1% % to 1.5% % to 2% % to 2.5% % to 3% % to 3.5% % to 4% yr GOC Range RCI.B (1) EV/ EBITDA Multiple T (1) EV/ EBITDA Multiple SJR.B (1) EV/ EBITDA Multiple Average Low* High** Data Points 0.5% to 1% % to 1.5% % to 2% % to 2.5% % to 3% % to 3.5% % to 4% (1) Data from January 2010 to present using TD estimates * 5% percentile value to exclude outliers ** 95% percentile value to exclude outliers Page 3 of 7

4 Exhibit 4. TD Securities: Telco/Cable Comp Table Source: Capital IQ, company reports, TD Securities Inc. Curr. Div EV/EBITDA P/E P/FCF Company Symbol Price Yield Mkt Cap 2014A 2015A 2016E 2017E 2014A 2015A 2016E 2017E 2014A 2015A 2016E 2017E Canadian Telecom BCE BCE $ % RESTRICTED TELUS T $ % $26, x 9.0x 8.6x 8.1x 18.5x 17.2x 17.9x 17.5x 25.6x 24.6x 35.4x 22.6x MTS MBT $ % RESTRICTED Rogers Communications RCI.B $ % $29, x 8.5x 8.3x 7.9x 19.4x 19.9x 19.4x 18.6x 20.6x 17.7x 17.7x 16.8x TeraGo TGO $ % $80 6.6x 6.5x 6.1x 5.3x nmf nmf nmf 101.7x 63.3x 12.0x 19.2x 16.0x Average (Ex-TeraGo) 8.5x 8.7x 8.4x 8.0x 19.0x 18.6x 18.6x 18.0x 23.1x 21.1x 26.5x 19.7x U.S. Telecom AT&T T $ % $262, x 8.1x 7.1x 6.7x 16.9x 15.6x 14.8x 14.1x 26.5x 16.5x 15.1x 14.3x Verizon VZ $ % $223, x 7.1x 7.1x 6.9x 16.4x 13.7x 14.0x 13.6x 16.7x 10.6x 15.0x 13.9x Sprint S $ % $24,825 n/a 9.1x 6.9x 5.8x n/a n/a n/a n/a n/a n/a n/a n/a T-Mobile USA TMUS $ % $38, x 8.1x 6.7x 5.6x n/a 54.9x 38.0x 23.4x n/a 56.0x 21.4x 11.6x Average 8.6x 8.1x 6.9x 6.2x 16.6x 28.1x 22.3x 17.0x 21.6x 27.7x 17.2x 13.3x Canadian Cable Shaw Communications SJR.B $ % $12, x 7.6x 7.6x 7.3x 14.1x 15.6x 23.6x 21.4x 27.1x 24.5x 33.2x 26.5x Cogeco Communications CCA $ % $3, x 6.7x 6.2x 5.7x 13.3x 13.3x 12.4x 11.3x 11.4x 11.0x 11.8x 9.4x Quebecor Inc. QBR.B $ % $5, x 6.8x 6.6x 6.1x 26.2x 22.3x 17.9x 14.6x 33.5x 29.4x 30.9x 16.4x Average 6.6x 7.0x 6.8x 6.4x 17.9x 17.1x 18.0x 15.7x 24.0x 21.6x 25.3x 17.4x U.S. Cable/International Cable Comcast CMCSA $ % $165, x 8.7x 8.2x 7.7x 22.9x 20.7x 19.0x 17.2x 20.3x 16.1x 18.4x 16.6x Charter Communications CHTR $ % $73,964 nmf nmf 9.9x 7.2x n/a n/a nmf 47.0x n/a n/a 18.1x 12.8x Cable ONE CABO $ % $3, x 11.0x 10.2x 10.1x n/a 34.2x 26.9x 26.5x n/a 33.9x 22.2x 21.7x Average 10.3x 9.9x 9.4x 8.3x 22.9x 27.5x 23.0x 30.2x 20.3x 25.0x 19.6x 17.0x Other Names Under Coverage Thomson Reuters TRI $ % $46, x 13.4x 11.7x 11.2x 27.9x 23.4x 21.0x 17.7x 24.4x 19.0x 19.6x 17.4x Sirius XM Canada XSR $ % $ x 9.5x 9.0x 7.7x 78.8x nmf 12.1x 15.8x 16.7x 11.0x 11.9x 9.3x Corus Entertainment CJR.B $ % $1, x 6.4x 7.9x 7.5x 7.2x 8.1x 12.7x 10.6x 6.2x 5.6x 8.1x 8.7x TVA Group TVA.B $ % $ x 4.7x 4.6x 3.6x nmf nmf 13.6x 7.7x 23.1x 2.5x nmf 15.2x DHX Media DHX.B $ % $ x 12.6x 10.5x 9.9x 71.5x 23.1x 20.4x 21.7x nmf 39.5x n/a 29.8x Torstar TS.B $ % $ x 0.0x 0.1x 1.1x 2.9x nmf nmf nmf 3.2x 20.0x nmf nmf Yellow Pages Y $ % $ x 3.8x 3.8x 3.4x 4.9x 8.0x 8.6x 7.6x 8.1x 5.0x 5.7x 5.5x Page 4 of 7

5 Exhibit 5. Communications: Justification of and Key Risks to Target Prices Company Name and Target Risk Rec. Ticker Price Rating Justification of Target Price Key Risks to Target Price TELUS Corp. (T-T) $46.00 HOLD MEDIUM We are using 8.9x 2017E wireless EBITDA and 7.4x 2017E wire line EBITDA, to derive our target price. Our $46.00 target price equates to 8.4x consolidated EBITDA and 18.3x EPS in Increased competition among the three wireless carriers in Canada; Aggressive pricing or promotions by new wireless entrants; Irrational capex spending on wireless infrastructure, or TELUS s IP network could compromise the company s FCF; Misguided or over-priced acquisitions; Regulatory changes could negatively impact TELUS s operations; Aggressive pricing or promotions from cable providers could impact TELUS wireline profits; As an income vehicle for some investors, higher interest rates would reduce the attractiveness of the company's dividend; An increase in scientific evidence about health risks from radiofrequency signals produced by wireless devices or transmission towers could negatively affect results and/or expose the company to legal claims. Shaw Communications Inc. (SJR.B-T) $31.00 BUY MEDIUM We believe that a segmented valuation is necessary for Shaw owing to the long-term investment cycle for wireless, and owing to the ownership of Corus shares that will not contribute to consolidated EBITDA. In our NAV, we use a 7.9x EBITDA multiple for consumer, 9.5x for Shaw Business (including ViaWest), and a DCF for the wireless business. 1) An increase in OTT disruption; 2) more aggressive TV/Internet pricing by ILECS; 3) execution risk in wireless, which is a new business for Shaw and one which can involve heavy capex and start-up losses; 4) subordinate voting share structure: as with all companies where voting control is not in the market, the controlling shareholder (Shaw family controls 80% of votes) and minority shareholders may not agree on issues that could affect the value of shares held by the minority; 5) increased video cord cutting or shaving by consumers; and 6) as an income vehicle for some investors, higher interest rates would reduce the attractiveness of the company s dividend. Rogers Communications Inc. (RCI.B-T) $64.00 BUY MEDIUM Our target price is based primarily on EV/EBITDA multiples. We use 8.9x 2017E EBITDA for wireless and 7.9x for cable and media to derive our target price. 1) Changes in the regulatory or competitive environment could negatively impact profitability at Rogers Wireless; 2) Increased wireless competition from Bell/TELUS or recapitalized new entrants; 3) accelerated fibre deployments by Bell; 4) Rogers could overpay for an acquisition; 5) some segments of Rogers could be negatively impacted by a prolonged economic downturn; 6) heavier than expected capex; 7) subordinate voting share structure: as with all companies where voting control is not in the market, the controlling shareholder (the Rogers family controls 90% of votes) and minority shareholders may not agree on issues that could affect the value of shares held by the minority; 8) as an income vehicle for some investors, higher interest rates would reduce the attractiveness of the company's dividend; and 9) an increase in scientific evidence about health risks from radiofrequency signals produced by wireless devices or transmission towers could negatively affect results and/or expose the company to legal claims. Source: TD Securities Inc. estimates Page 5 of 7

6 Industry Note Equity Research July 27, 2016 July 27, 2016 TD Securities Equity Research Disclosures Distribution of Research Ratings^ Investment Services Provided* 75% REDUCE - 3.8% 62.84% BUY % 50% 34.97% 25% HOLD % 0% 2.19% BUY HOLD REDUCE Definition of Research Ratings ACTION LIST BUY: The stock's total return is expected to exceed a minimum of 15%, on a risk-adjusted basis, over the next 12 months and it is a top pick in the Analyst's sector. BUY: The stock s total return is expected to exceed a minimum of 15%, on a risk-adjusted basis, over the next 12 months. SPECULATIVE BUY: The stock's total return is expected to exceed 30% over the next 12 months; however, there is material event risk associated with the investment that could result in significant loss. HOLD: The stock s total return is expected to be between 0% and 15%, on a risk-adjusted basis, over the next 12 months. TENDER: Investors are advised to tender their shares to a specific offer for the company's securities or to support a proposed combination reflecting our view that a superior offer is not forthcoming. REDUCE: The stock s total return is expected to be negative over the next 12 months. Overall Risk Rating in order of increasing risk: Low (7.4% of coverage universe), Medium (35.6%), High (43.0%), Speculative (14.0%) Research Dissemination Policy TD Securities makes its research products available in electronic and/or printed formats and as soon as practicable distributes them to its institutional clients who are entitled to receive them. The Action Notes are distributed by , and are available in PDFform on Thomson Reuters, Bloomberg, S&P Capital IQ and FactSet. Research Reports are distributed by ; they are also printed and distributed by courier to our entitled clients. PDFs of Reports are available on Thomson Reuters, Bloomberg, S&P Capital IQ and FactSet. All research is available by password to entitled institutional clients at Analyst Certification Each analyst of TD Securities Inc. whose name appears on page 1 of this research report hereby certifies that (i) the recommendations and opinions expressed in the research report accurately reflect the research analyst's personal views about any and all of the securities or issuers discussed herein that are within the analyst s coverage universe and (ii) no part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the provision of specific recommendations or views expressed by the research analyst in the research report. Disclaimer This material is for general informational purposes only and is not investment advice nor does it constitute an offer, recommendation or solicitation to buy or sell a particular financial instrument. It does not have regard to the specific investment objectives, financial situation, risk profile or the particular needs of any specific person who may receive this material. No representation is made that the information contained herein is accurate in all material respects, complete or up to date, nor that it has been independently verified by TD Securities. Recipients of this analysis or report are to contact the representative in their local jurisdiction with regards to any matters or questions arising from, or in connection with, the analysis or report. Historic information regarding performance is not indicative of future results and investors should understand that statements regarding future prospects may not be realized. All investments entail risk, including potential loss of principal invested. Performance analysis is based on certain assumptions, the results of which may vary significantly depending on the modelling inputs assumed. This material, including all opinions, estimates and other information, constitute TD Securities judgment as of the date hereof and is subject to change without notice. The price, value of and income from any of the securities mentioned in this material can fall as well as rise. Any market valuations contained herein are indicative values as of the time and date indicated. Such market valuations are believed to be reliable, but TD Securities does not warrant their completeness or accuracy. Different prices and/or valuations may be available elsewhere and TD Securities suggests that valuations from other sources be obtained for comparison purposes. Any price or valuation constitutes TD Securities judgment and is subject to change without notice. Actual quotations could differ subject to market conditions and other factors. TD Securities disclaims any and all liability relating to the information herein, including without limitation any express or implied representations or warranties for, statements contained in, and omissions from, the information. TD Securities is not liable for any errors or omissions in such information or for any loss or damage suffered, directly or indirectly, from the use of this information. TD Securities may have effected or may effect transactions for its own account in the securities described herein. No proposed customer or counterparty relationship is intended or implied between TD Securities and a recipient of this document. TD Securities makes no representation as to any tax, accounting, legal or regulatory issues. Investors should seek their own legal, financial and tax advice regarding the appropriateness of investing in any securities or pursuing any strategies discussed herein. Investors should also carefully consider any risks involved. Any transaction entered into is in reliance only upon the investor s judgment as to financial, suitability and risk criteria. TD Securities does not hold itself out to be an advisor in these circumstances, nor do any of its representatives have the authority to do so. The information contained herein is not intended for distribution to, or use by, any person in any jurisdiction where such distribution or use would be contrary to applicable law or regulation or which would subject TD Securities to additional licensing or registration requirements. It may not be copied, reproduced, posted, transmitted or redistributed in any without the prior written consent of TD Securities. Page 6 of 7

7 Industry Note Equity Research July 27, 2016 July 27, 2016 If you would like to unsubscribe from our distribution lists at any time, please contact your TD Securities Sales Contact. If you are located in Europe, Asia, Australia or New Zealand you may also unsubscribe by ing us at You can access our Privacy Policy here ( Australia: If you receive this document and you are domiciled in Australia, please note that this report is intended to be issued for general information purposes only and distributed through the Toronto Dominion Australia Limited ( TDAL ). TDAL does not hold itself out to be providing financial advice in these circumstances. TD Securities is a trademark and represents certain investment dealing and advisory activities of Toronto-Dominion Bank and its subsidiaries, including TDAL. The Toronto-Dominion Bank is not an authorized deposittaking or financial services institution in Australia. TDAL is a holder of an Australian Financial Services License (404698) and is regulated by the Australian Securities and Investments Commission. Canada: Canadian clients wishing to effect transactions in any security discussed herein should do so through a qualified salesperson of TD Securities or TD Securities Inc. TD Securities Inc. is a member of the Canadian Investor Protection Fund. Hong Kong: This document, which is intended to be issued in Hong Kong only to Professional Investors within the meaning of the Securities and Futures Ordinance (the "SFO") and the Securities and Futures (Professional Investor) Rules made under the SFO, has been distributed through Toronto-Dominion Bank, Hong Kong Branch, which is regulated by the Hong Kong Monetary Authority. China, India and South Korea: Insofar as the document is received by any persons in the People's Republic of China ( PRC ) (which, for such purposes, does not include Hong Kong, Macau or Taiwan), India and South Korea, it is intended only to be issued to persons who have the relevant qualifications to engage in the investment activity mentioned in this document. The recipient is responsible for obtaining all relevant government regulatory approvals/licenses themselves, and represents and warrants to TD Bank that the recipient's investments in those securities do not violate any law or regulation, including, but not limited to, any relevant foreign exchange regulations and/or overseas investment regulations. The Toronto- Dominion Bank has a representative office in Shanghai, Mumbai and Seoul which should be contacted for any general enquiry related to The Toronto-Dominion Bank or its business. However, neither any of the Toronto-Dominion Bank offshore branches/subsidiaries nor its representative offices are permitted to conduct business within the borders of the PRC, India and South Korea. In locations in Asia where the Bank does not hold licenses to conduct business in financial services, it is not our intention to, and the information contained in this document should not be construed as, conducting any regulated financial activity, including dealing in, or the provision of advice in relation to, any regulated instrument or product. This publication is for general information only, without addressing any particular needs of any individual or entity, and should not be relied upon without obtaining specific advice in the context of specific circumstances. Japan: For Japanese residents, please note that TD Securities is not licensed in Japan and this is being provided to qualified financial institutions ( QFI ) only under a relevant exemption to the Financial Instruments and Exchange Law. New Zealand: The Toronto-Dominion Bank is not a registered bank in New Zealand under the Reserve Bank Act Singapore: This report is distributed in Singapore by The Toronto-Dominion Bank, Singapore Branch, and recipients in Singapore of this report are to contact The Toronto-Dominion Bank, Singapore Branch in respect of any matters arising from, or in connection with, this report. The Toronto-Dominion Bank, Singapore Branch is regulated by the Monetary Authority of Singapore. Where this report is issued or promulgated in Singapore, it is only intended for distribution to a person who is an accredited investor, expert investor or institutional investor as defined in the Securities and Futures Act (Cap. 289) or the Securities and Futures (Prescribed Specific Classes of Investors) Regulations 2005 issued by the Monetary Authority of Singapore. United Kingdom and Europe: This document is prepared, issued or approved for issuance in the UK and Europe by TD Securities Limited in respect of investment business as agent and introducer for TD Bank. The Toronto-Dominion Bank is authorised by the Prudential Regulation Authority and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. TD Securities Limited is authorised and regulated by the Financial Conduct Authority. Insofar as the document is issued in or to the United Kingdom or Europe, it is intended only to be issued to persons who (i) are persons falling within Article 19(5) ("Investment professional") of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended, the "Financial Promotion Order"), (ii) are persons falling within Article 49(2)(a) to (d) ("High net worth companies, unincorporated associations, etc.") of the Financial Promotion Order, or (iii) are persons to whom an invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act 2000) in connection with the issue or sale of any securities may otherwise lawfully be communicated or caused to be communicated. European clients wishing to effect transactions in any security discussed herein should do so through a qualified salesperson of TD Securities Limited. Insofar as the information in this report is issued in the U.K. and Europe, it has been issued with the prior approval of TD Securities Limited. United States: U.S. clients wishing to effect transactions in any security discussed herein must do so through a registered representative of TD Securities (USA) LLC. TD Securities is a trademark of TD Bank and represents TD Securities Inc., TD Securities (USA) LLC and TD Securities Limited and certain investment and corporate banking activities of TD Bank and its subsidiaries. Copyright 2016 The Toronto-Dominion Bank. All rights reserved. Full disclosures for all companies covered by TD Securities can be viewed at Page 7 of 7