The dividend yields of Canadian telecom stocks are hovering near 20-year highs, even though bond yields are nosediving and central banks embrace rate cuts. This mismatch suggests that BCE Inc. BCE-T and Telus Corp. T-T could be ripe for the taking.
“Given their stability and high dividend yields, telecom companies have been viewed historically as bond-proxy stocks, making the sector sensitive to changes in interest rates,” Stephanie Price, an analyst at CIBC World Markets, said in a note.
That’s good news for long-suffering investors who have seen their telecom stocks struggle as bond yields soared to multiyear highs over the past couple of years.
Declining interest rates tend to send bond yields lower as well. As bond yields shrink, dividends look more attractive.
Already, the Bank of Canada has cut its key rate three times this year, and economists expect that more cuts are coming. On Wednesday, the Fed is widely expected to cut its key rate by at least a quarter of a percentage point, making this week a potentially pivotal week for monetary policy – and dividends.
Government bonds and many dividend stocks have already responded to this shift. But the yields on Canadian telecom stocks, while off their recent peaks as share prices have rebounded modestly this year, remain curiously high.
Ms. Price calculated that the average telecom dividend yield should be 4.6 per cent, based on the historical average spread between the sector and the 10-year U.S. Treasury bond.
The actual dividend yield, though, is considerably higher, at 7.5 per cent on average. That is unusually high relative to the 3.68-per-cent yield – before Monday’s trading activity – on the 10-year bond.
BCE’s yield is 8.3 per cent and Telus’s yield is close to 6.8 per cent. Full disclosure: I own both stocks.
One reason telecom yields remain near historically high levels is because of rising competitive pressures within the wireless market and regulatory challenges. In addition, BCE’s high debt levels add to concerns over its ability to raise its quarterly distribution, or even maintain it.
These issues are weighing on share prices.
Ms. Price estimates that telecom revenue from its customers, on average, will decline by low single digits over the course of 2024, which suggests that competitive pressures won’t let up this year.
Nonetheless, she’s upbeat on the stock.
She expects that the regulatory headwinds will abate after the Canadian Radio-television and Telecommunications Commission delivers its next rates decision on third-party internet access – what competitors pay to access the networks of the big telecom companies – before the end of the year.
More importantly, she believes that investors will move into high-yielding stocks as bond yields decline.
Over the past 20 years, when the yield on the 10-year U.S. Treasury bond has declined by at least three-quarters of a percentage point, telecom share prices have gained an average of 13.3 per cent.
Exclude the marketwide downturn of 2007-08, during the financial crisis, and the average gain is more than 20 per cent.
“We expect the telcos, BCE and Telus, to benefit more from falling interest rates than the cablecos given their higher dividend yields,” Ms. Price said in her note.
In other words, come for the dividends but stay for the rally.