The Motley Fool

Why BCE Inc. Is Overvalued and Set for a Huge Decline

BCE Inc. (TSX:BCE)(NYSE:BCE) is a top pick for income investors because of its high yield and the safe nature of the business. Canadians can’t live without their phones, and everyone has to pay their phone bill. But the times have changed, and the price gouging by the Big Three Canadian telecoms may be coming to an end as a new entrant, Shaw Communications Inc.’s Freedom Mobile, may introduce intense pricing pressure for BCE and its peers.

Although Freedom Mobile isn’t at the same level in terms of network performance, it is investing heavily in improving its infrastructure and will be charging less for its services. This means that Canadians who value affordability more than performance will be switching over from wireless providers like BCE into Freedom Mobile.

Have we seen the peak number of BCE’s subscribers?

BCE is Canada’s largest wireless provider, and it’s very hard to grow when a company is that size. I believe pricing pressure and subscriber loss may have a big impact on BCE’s ability to grow its dividend over the next five years.

If you’re a retiree, then you might not care about the fluctuations in the stock price; you might only care about the dividend you receive from the company. This is simply not a good strategy because if a time comes when you need to sell the stock, you’ll lose out on huge returns. Also, your dividend may stop growing over the next few years because of issues present in the company. This means your dividend will be a lot less than if you’d invested in a company with a durable competitive advantage and the ability to grow its dividend on a regular basis.

BCE still has a safe dividend, and it won’t be cut anytime in the next few years, unless there’s a nasty market crash, but I don’t see BCE increasing its dividend as fast as it did in the past. If competition brought on by Freedom Mobile is too much, we may even see the dividend remain flat for years.

Billionaire investor Prem Watsa recently dumped a huge stake in BCE earlier in the year, and for good reason. The stock is really expensive, and there will be large headwinds in the company’s future.

The stock currently trades at a huge premium for no good reason, other than the fact that it’s a popular core holding for income investors. Times are changing, and this company should be trading at a discount–not a premium–given the headwinds that BCE will be facing over the next five years.

The stock trades at a 18.4 price-to-earnings multiple with a 4.1 price-to book multiple, and a 7.6 price-to-cash flow multiple; all of which are higher than its five-year historical average values of 15.6, 3.3, and 6.5, respectively. The stock is overvalued and could be headed for major losses in 2017. The capital losses may even be more than the dividend yield paid by the stock. If you’re an income investor, it’s time to allocate your cash into something else for now.

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Fool contributor Joey Frenette has no position in any stocks mentioned.

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