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Want Growth and Big Yields? Then Check Out The Two Cogeco Stocks
The better name would be the Cogeco Complex because, well, it's a little complicated
If I haven’t made it clear by now, let me officially do so. Your favouritest/handsomest/funniest newsletter writer prefers stocks that have simple operating structures, easy-to-understand stories, and basic bull theses. Mostly because I’m a moron, but also because the average investor is too a moron.
Those of us spending all day in the weeds often forget the kind of cringe-worthy behaviour that many of our investing peers do. These people invest based on half-baked stories, ideas from people they trust (or just happen to meet), and intuition. You’re ahead of 90% of investors just by reading this newsletter, and not because of my guidance, either. It’s because I actually crack open the annual and quarterly reports, something most people don’t even bother with.
Even though I do the work, I’m really only looking for good companies in boring sectors that generate consistently growing revenue and free cash flow per share. I want simple stories because I know a big source of potential buyers in the future will load up based on a simple story too. And it’s partly because I know those stocks tend to pay growing dividends, a fantastic signaling mechanism for good returns and because I’ve retired off dividends.
Buy these high-quality companies when they’re cheap and I’m confident that’s all I need to boost my returns from meh to pretty good, which is exactly what I’m hoping for. Because that’s all you need to be successful.
Or, as I said a few months ago, I really think not blowing up is a superpower.
I’m trying to reform myself from a value investor who defaults to cheap companies to a dividend investor who defaults to higher quality companies that happen to trade at cheap prices. I believe this leads to both higher returns and fewer headaches over the long-term. I feel like I’m most of the way there, but I still stumble and fall into the proverbial abyss sometimes.
It is with this in mind your author recently somewhat reluctantly took a look at both Cogeco Inc (TSX:CGO) and its subsidiary, Cogeco Communications (TSX:CCA), a needlessly complex corporate structure that annoyed me when I first started doing research and annoys me today. Will the stocks’ other virtues be enough for me to take a position?
Let’s take a closer look.
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Cogeco Inc. is a holding company which holds Cogeco Communications, as well as Cogeco Media. Cogeco Communications owns Cogeco Connexion (Canadian broadband servies) and Cogeco US (American broadband services).
Let’s tackle the ownership structure before going further into the business. Cogeco (which we’ll call the parent from now on) owns a 35% stake in the subsidiary, which we’ll call Communications. This is in the form of multiple voting shares, so this relatively small ownership stake comes with 84% of voting rights.
The company is nice enough to include an ownership diagram, which explains it pretty nicely.
The media division is, essentially, meaningless in the scheme of things, so we’ll ignore it.
Another large shareholder in Communications is Rogers, after a 2020 acquisition attempt was thwarted by the parent. More on that later.
With such close ownership ties, you’d think the two stocks would move practically in lockstep with each other, and that was the case up until a couple years ago.
You can see a big spike in Communications shares right around the time Rogers officially went public with its takeover offer. The gap has since narrowed but Communications has delivered slightly better returns over time. Although the gap is so small it’s virtually meaningless.
Let’s talk about the actual business now. This part will focus on Communications, since the parent is basically a holding company for Communications shares.
Communications has two business units (Canada and the US) with approximately a 50/50 split in revenue between the two. Approximately 50% of total revenue comes from internet service, 32% from video, and 18% from a bunch of (presumably) seniors who are still worried their their grandkids don’t know how to call a cell phone.
Fun fact: I knew a millennial couple who maintained a $50+ per month landline so they could call long-distance (one province over) for about an hour a month for cheap. They were constantly short on money, but insisted this was a good deal because of “long distance”. This went on for a decade until it was mercifully stopped.
I like this mix and have to admit I was pleasantly surprised at internet being such a big weighting. The stereotype is Cogeco is a cable company only, but that part of the business isn’t as big as I first thought.
Communications has a pretty simple growth strategy. It acquires smaller local cable operators in the United States, and adding them to the pile, taking synergies with each deal. This is a formula it has been using for a while now, with a reasonable amount of success. Notable recent acquisitions include:
2012: Atlantic Broadband
2015: MetroCast Connecticut
2018: The rest of MetroCast
2020: Thames Valley Communications, also in Connecticut
2021: WideOpenWest in Ohio
There are a few smaller local acquisitions mixed in there as well, but those are the big U.S. ones.
The strategy has been working fairly well until recently, when a few different things combined to send Communications stock reeling. Results from the U.S. division — particularly the assets in Ohio — have been weak, with the most recent results showing revenue down 5.2% in the U.S. division and a 7.8% EBITDA decline, at least compared with the same quarter last year. The company is also telling investors free cash flow will temporarily be down in 2023 as it spends somewhat aggressively on network expansions. Cash flows are still growing nicely, but free cash flow is what really matters here.
Cogeco’s Canadian business is slowly shrinking over time, especially the cable and home phone parts of it. This is somewhat offset by additional internet subscribers, but it isn’t enough to buck the trend. Fortunately, the company is able to raise prices to continue increasing revenue. From the 2022 annual report:
Revenue increased 3.4% from 2021 to 2022, while operating expenses crept up about the same amount. The Canadian operations are basically a cash cow at this point, a slowly shrinking ice cube that will still churn out plenty of sweet predictable cash flow, plus the potential for the odd acquisition.
U.S. results are much worse once we exclude the recent Ohio acquisition. From the 2022 annual report again:
More recent results aren’t very encouraging either, but to Communications’ credit the numbers did improve in its most recent quarter, at least on the internet side.
To put those numbers more bluntly, the U.S. side of Cogeco Communications lost more than 4% of its total customers in just six months. That’s a big ol’ yikes from me, kids.
This translated into a 2.7% revenue loss on a year-over-year basis for the American division, at least when comparing results in constant currency. Revenue was up when converted back to Canadian Dollars, but that’s not something that’s sustainable over the long-term. And expenses increased faster than revenue.
I’ve spent a while focusing on the negatives of the U.S. ops, so let’s spend a little time on the positives. This is still a really profitable business with nice margins. The U.S. business is growing outside of Ohio, and part of the elevated capex costs I outlined earlier are to expand the Canadian operations to smaller places that don’t have broadband access. Both those trends should help mitigate weakness from Ohio. And, as I’ve mentioned, the losses in Ohio did stabilize in the second quarter compared to the first quarter.
At this point, organic growth is going to come from price increases on a slightly smaller group of customers, a group shrinking slightly faster in the U.S. than Canada. But there are numerous acquisitive growth opportunities including other smaller cable deals, more tech or streaming focused deals (like the recent Oxio acquisition in the Quebec market). The core business is a melting ice cube, but there’s tons of free cash flow to support further acquisitions.
Finally, a quick note on the debt, since many seem to think the company has too much of it. I’m not worried about the debt at all. It does the same thing every big acquisition — levering up to buy the asset and then paying off the debt. There are no major debt maturities until 2025, either, although the 2025 maturity is a whopper of more than $2B.
One more note on Cogeco’s potential growth. The company has acquired mobile spectrum for much of the southern Ontario and Quebec market, taking advantage of government auctions designed to get smaller players into wireless and hopefully bring down prices for consumers. This could be the start of something big or, more likely, the company will just hold onto this spectrum and sell it to someone in a few years. I wouldn’t be surprised to see the spectrum sold and used to pay down some of the debt come 2025.
Dividends & Buybacks
Communications has delivered a nice combination of steadily increasing dividends, consistent share buybacks, and has maintained an absolutely succulent payout ratio.
First, the dividend. Communications has raised the payout each year since 2010 and has delivered a 10% dividend growth rate since 2014. The payout is currently $0.776 per share each quarter, good enough for a 4.7% yield. Oh, and the payout is approximately 30% of free cash flow.
The parent has similar dividend growth rates and offers a slightly higher yield closer to 5%. I think it makes sense for the parent to have a slightly bigger yield because it gets about 10% of its revenue from radio, a much worse business than telecom.
I can think of only a couple of Canadian stocks that offer Communications’ combination of high dividend yields today and the potential to grow the payout in the future.
Communications is also repurchasing shares at a steady pace, retiring approximately 25% of the float since May, 2019. Further buybacks may be a little bit limited since the parent and Rogers Communications own so many shares, but I certainly like the looks of this graph.
This share buyback also has the benefit of helping the dividend payout ratio and maintaining earnings per share. Plus, as you’ll see in the valuation section, these shares are damned cheap. Management is doing a fine job putting capital to work buying back shares and paying off debt rather than chasing another acquisition.
There’s not a lot to say here. Shares are really cheap. Period.
Let’s start with trailing earnings. Net income over the last 12 months was $9.08 per share for Communications. Shares trade hands at $65.63 as I write this. That’s a mere 7.2x trailing earnings. The parent trades at a similar valuation.
Communications is even cheaper on a free cash flow basis. If we strip out one-time network expansion fees in Canada that were partially paid for by the government, Communications generated $582M in FCF in fiscal 2022. The current market cap on all classes of Communications shares is $3B. That puts shares at just 5.2x FCF.
And remember, Communications is spending about $40M per quarter on buybacks. Meaning, as it stands today, it’s buying back 1.3% of the company back every quarter.
Rogers paid $40.50 per share for Shaw, or 26x earnings. That’s not entirely an accurate look, since some of those assets were immediately sold to Quebecor, but there’s no need to really do the math here. If you think Rogers paid anywhere close to fair value for Shaw, then Cogeco shares are ludicrously cheap.
Speaking of takeovers…
The Rogers deal
Back in September 2020, Rogers Communications teamed with Altice USA to try to purchase both Cogeco and Cogeco Communications. Altice would have taken the U.S. assets, while Rogers was happy to snap up the Canadian operations.
After the initial offer was rejected by the controlling Audet family, the partners raised the bid to $123 per Cogeco share and $150 per Cogeco Communications share. The family again refused the sale and Rogers was left holding large blocks of shares of both companies. At the time the stake was 41% of the subordinate shares of the parent and 33% of the subordinate shares of Communications.
Rogers has held onto its shares despite moving on and acquiring Shaw. There have been periodic rumblings it would be forced to sell the stakes in the two Cogeco entities, but nothing has happened as of yet. It appears the company is still holding out hope it can one day acquire its smaller rival and spin off the U.S. assets to someone else. Or it may be waiting for a better price.
There’s two ways you can look at the situation. A pessimist might focus on the Audet family saying no to the offer, saying there’s no way shareholders will ever get what the company is worth. I prefer a more optimistic look. Rogers — an informed buyer if there ever was one — offered $150 per share for Communications and $123 for the parent less than three years ago. You can buy shares in each today for $66.80 and $58.37, respectively, and earnings are up about 15-20% since. I’m happy to get in at that valuation.
The bottom line
I like Cogeco, and I bought a little of each for my portfolio back in the blink-and-you’ll-miss-it bear market of March, 2023. Rather than trying to figure out which one I’d rather own over time, I simply chose both. They’re basically the same thing anyway.
I like the telecom business, the valuation, the potential for juuuuuuust enough expansion to lead to a little organic growth (at least in Canada), the amount of free cash flow generated, and, perhaps most importantly, the succulent dividend and the smart share buybacks.
This is one of those rare businesses on sale for a bargain basement price. I’m happy to sit back, relax, and collect my 5%(ish) dividend while the market bids this back up to the 10-12x earnings multiple it should have.
I know at least a few of you are unsure which Cogeco to buy. Like I said, my strategy was to buy a little of both, just in case the founding family ever gets rid of one class of shares like Power Corp and Power Financial did a few years ago. Long-term I think it doesn’t really matter which one you choose. They’re both damned cheap and, as a just said, basically the same anyway.
Disclosure: Author owns both Cogeco Communications and Cogeco Inc. Nothing written above constitutes financial advice. Consult a qualified financial advisor before making any investment decisions.