Why Telecoms Should Be a Core Corporate Bond Component

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Trevor Bateman, CFA, CA

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Trevor Bateman, credit analyst in the fixed-income research and portfolio management team at CIBC Asset Management.

On the question of what our view is on the telecom industry for 2021 and the major themes, overall, we have a generally favourable view of the industry fundamentals and believe that telecom bonds are a core component of a corporate bond portfolio.

We do like the industry structure here in Canada, with really three national operators and some smaller, more regional operators. But that generally is supportive of rational competition, which fosters a profitable industry.

When I look at the fundamentals, 2020 negatively impacted the industry in terms of revenues and EBITDA. And we see a rebound occurring in 2021. Generally speaking, we’re looking for revenues and earnings to grow in the mid-single digits area in 2021, and that supports cash flow growth and positive free cash flow.

First of all, on the wireless business, we see the customer loading or new customer additions picking up through 2021. 2020 was negatively impacted as these operators on the wireless side were required to close some of their retail networks by regional government lockdowns and restrictions on non-essential retail. We see that lessening or easing in 2021, and, therefore, would expect a more natural, I guess, industry growth in terms of customer loadings, and that helps support our topline revenue growth. The pace of that growth will be a function of the restrictions easing, which will be driven by the success of the vaccination rollouts across the country.

Another major driver of revenue growth this year: we expect that overage charges, which generally accounts for 4% of wireless service revenues for the industry in general — that will rebound. Part of the rebound will be driven by the carriers’ initial support programs, which were put in place when the pandemic first erupted. Carriers put in place policies to help their clients, their customers, with bill payments, bill deferrals, but also on helping them with maybe relaxing some of their overage charges. I think that will begin to fade in 2021, and that will be a source of revenue growth.

And then on roaming revenues is another important revenue driver. That side of the revenue stream was hit hard by the pandemic, and that, for the industry, it counts for about 7% of wireless service revenues. And I would expect that to recover in 2021, probably more than in latter half of the year, assuming that international travel restrictions may begin to ease later on in 2021, and that should help support the resumption of roaming revenues and maybe see some growth.

In terms of the wireline side of the business — so that’s your typical video and internet — the internet side was fairly resilient during 2020 and during the lockdown, as the society moved to a more stay-at-home society, work-from-home economy. Wireline internet was fairly resilient today; you would expect it to remain resilient in 2021. As customers upgraded their internet packages in 2020 will likely keep them, and that supports revenues in 2021.

And then on the video side or the TV side of the business, somewhat skeptical as to whether or not that will hold up as well as the stay-at-home society perhaps shifts to a more relaxed world, and the need for home entertainment may not be as important as it was in 2020. So, I’m looking for a resumption in terms of cord cutting, which may hurt the video side of the business.

But beyond the revenue growth, when we look at the balance sheets of these companies, it’s a little different story. Right now, as we head in at the early part of 2021, I characterize balance sheets as generally stretched as measured by debt to EBITDA. And compared to where credit rating agency thresholds are, they’re at the top, if not a little bit in excess of rating agency tolerance for the current credit ratings. And at the high end, we have Telus at 3.4 times, we have Rogers at 3.1, BCE at three.

Considering credit ratings, they’re stable overall with two exceptions. S&P has Telus’s BBB+ on negative outlook. That’s because of its elevated leverage. So, key for Telus will be managing any spectrum purchases, as well as the concurrent Telus International IPO and how that could defray some of the costs. And then Shaw, which has a BBB- at S&P, it’s currently on positive trend. And certainly over the last year, the company has demonstrated it’s on path to support an initial upgrade by S&P in sometime in 2021.

Starting early in 2021, I’d characterize telecom bonds as rich, especially when you compare them to some bank bonds. We’re a little bit skeptical in terms of how much more room there is for telecom bonds to tighten. So, we’re a little bit cautious on valuation.

We’re estimating that new issuance in this space will be about $10 billion. That’s up from where we saw it last year — by our numbers about eight billion. A large part of that increase is related to potential funding for spectrum, as well as perhaps early redemptions of 2022 bond maturities. At this level of new issuance, it’s manageable. I think the primary market can digest that level of new issuance. I do not anticipate any negative impact on the secondary market, but we’ll have to see how that unfolds.

Finally, on ESG — so that’s environmental, social and governance — I think this will continue to be an emerging theme in 2021. Interestingly, there has been no Canadian-dollar green bond issued by a Canadian telecom company so far to date. In contrast to other jurisdictions around the world, we’ve seen green bonds in the telecom sector. For example, in the U.S., Verizon was the first telecom operator to issue a green bond back in February 2009, where it raised over a billion dollars in proceeds and earmarked those funds for renewable energy, energy efficiency, green bonds, etc. I would think that 2021 for the Canadian industry would be a good year for the launch of the industry’s initial green bond issuance.

A critical event will occur in 2021, and that is the upcoming wireless spectrum auction that begins in the middle of June. Key type of wireless spectrum will be auctioned off by the federal government and it’s key for 5G technology. And I would expect it to be well bid by the participants in the wireless sector. Historically, those expenditures to buy wireless spectrum are usually debt funded. So, we’re watching this industry in terms of how much leverage will increase in 2021.