Many investors have telecom stocks as the foundation of their portfolio. When looking at the sector it’s easy to see why.
Canada’s telecom sector is dominated by three players, especially on the wireless side. Sure, there are start-up players jockeying to gain market share in major centres, but for the most part, they’re nothing but an amusing sideshow. Geographically, Canada is a tough place for a wireless start up, since our country is filled with so much empty space. That makes it really expensive for a new player to roll out a truly national network.
In 2013 Verizon openly mused about entering the Canadian market before ultimately deciding to go in a different direction. Verizon is one of the largest wireless providers in the world. If it looked at Canada and decided it wasn’t attractive, what chance does a smaller carrier have?
Telecom investors get a sector that’s dominated by entrenched incumbents, which is good for profits. Folks aren’t about to give up their cell phones, and as long as the population keeps growing there will be a steady supply of customers.
An underrated moat
Even though it faces competition from each of so-called big three, Manitoba Telecom is still tops in its home province.
There are several reasons why Manitobans are sticking with the incumbent. First of all, it held a monopoly in the province for years when it was owned by the government, and people are used to it. As we all know, it’s much easier to keep a customer than it is to gain a new one.
The company is also one of the biggest employers in the province, and has the naming rights for the arena that’s home to the Winnipeg Jets. Manitobans identify with the company.
Since the company still dominates television, home phone, and Internet service, it can offer bundling discounts to its customers. That creates another incentive for them to stay.
Put all these together, and Manitoba Telecom has a pretty solid moat. You have to be doing something right to not only compete with the big boys, but beat them. Even in wireless, Manitoba Telecom still holds a dominant position.
Currently, BCE trades at 18.3 times earnings, while Manitoba Telecom trades at just 15.4 times earnings. Based on 2015’s earnings estimates, BCE trades at a forward P/E ratio of 16.4, while Manitoba Telecom trades at a forward P/E of 16.1.
Including its preferred shares, BCE has a debt-to-equity ratio of 2.4, while Manitoba Telecom’s number is approximately 0.8. That’s a huge difference, although it is partially skewed by BCE’s recent acquisition of Bell Aliant. Manitoba Telecom also trades at 1.95 times book value, while BCE is more than four times its book value.
There are reasons why Manitoba Telecom is cheaper than BCE—mostly because it has a pension shortfall, which is leading investors to speculate that the generous 6.5% dividend is about to be slashed—but it shouldn’t be as cheap as it is.
With BCE making headlines last summer with the Bell Aliant takeover, I believe Telus could be mulling a bid for Manitoba Telecom.
On the surface it makes sense. The geography meshes well, and Telus could generate some serious synergies by combining sales staff. Interest rates are cheap, which makes this a good time to buy.
Of course, it isn’t a slam dunk. The federal government might not be so keen on further consolidation. Manitoba Telecom shareholders would want a premium for being taken out, which moves the stock from cheap to not-so-cheap territory. And Telus is already sitting on quite a bit of debt. But still, the possibility is very real. Even a foreign telecom could use a Manitoba Telecom acquisition as a foothold into Canada, expanding the brand.
Many investors ignore Manitoba Telecom because it’s small and limited to Manitoba. But in reality, it’s cheaper than the competition, has an underrated moat, and could be taken over. Those are all compelling reasons to like it over BCE, which is sitting on a lot of debt.
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Fool contributor Nelson Smith has no position in any stocks mentioned. Verizon is a recommendation of Stock Advisor Canada.