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Ottawa's telecom ruling is a gift to investors

The shares of Telus, BCE and Rogers Communications ended the week at prices not seen since mid-to-late February.

Darren Calabrese/THE CANADIAN PRESS

In its latest efforts to foster more competition in the wireless industry for consumers, Ottawa may have given a gift to investors.

The big three telecom players saw more than $2.5-billion wiped from their combined market valuations last week after the government brought its weight to bear on the sector. First, the Canadian Radio-television and Telecommunications Commission imposed new rules of conduct, which included caps on data charges and a two-year limit on the duration of wireless phone contracts. Then Industry Canada nixed Telus Corp.'s plans to purchase Mobilicity, even though the new wireless entrant is struggling to stay afloat.

The shares of Telus, BCE Inc. and Rogers Communications Inc. ended the week at prices not seen since mid-to-late February, while the S&P/TSX Capped Telecommunications Services Index slipped 2.3 per cent, in line with the broader market.

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Some of the weakness reflects concerns about rising rates on government bonds, which make the yields on telecom stocks less attractive. But increased regulation and uncertainty are also dragging down the share prices of the incumbent carriers, giving investors a chance to buy into the high-yielding sector at a discount. At current prices, Rogers and Telus are paying dividends of almost 4 per cent and BCE of 5 per cent.

"Industry Canada's announcements introduced significant short-term uncertainty into the Canadian wireless sector and will likely represent an overhang on stocks across the sector through the summer. That said, we don't believe it meaningfully changes the longer-term investment thesis," Tim Casey, an analyst at BMO Nesbitt Burns, wrote in a report last week.

"We continue to rate the telecommunications sector 'outperform' based on its attractive yield in the current low interest rate environment supported by stable free cash flow generation. In short, the oligopoly remains intact and near-term dividend growth appears to be sustainable for the big three," Mr. Casey wrote.

To be sure, there are reasons to expect volatility in the short term.

Industry Canada also delayed its next auction of wireless spectrum to give the three struggling new entrants more time to find financial partners or purchasers. The auction is now scheduled for January instead of November. "This will leave investors in limbo for another two to three months as all the [new] players negotiate behind the scenes," Vince Valentini, of TD Securities Inc., noted. "We believe increased risk of a surviving fourth carrier will creep into telco valuations."

Even with last week's pullback, the Canadian telecom share index is up more than 7 per cent this year, compared with an increase of less than 2 per cent for the overall market. Some analysts say that has left the incumbents' stocks trading at a premium to major national carriers in other countries.

"Premium valuation for the sector, increasing long bond yields, and further regulatory uncertainty that could lead to heightened competition will provide an overhang on Canadian telco stocks for the near term," according to Greg MacDonald, of Macquarie Capital Markets Canada Ltd. He sees Rogers Communications shares most at risk right now, given that the company has the highest exposure of its peers to the wireless market.

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Colin Moore, of Credit Suisse Securities (Canada) Inc., says the big three carriers are unlikely to feel any lasting effects this year from events last week. But he added it's important investors be selective in their stock picks.

He favours Quebecor Inc. for its strong cable assets and healthy market position as a new wireless challenger. He also likes Telus for its momentum and clear plan for returning capital to shareholders. Mr. Moore has an "outperform" rating on both companies, with a target of $52 on the shares of Quebecor and $40 on those of Telus.

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