Cogeco Communication Inc (TSX: CCA) is the second-largest cable operator in Québec and Ontario and the ninth largest in the United States.  Cogeco now enjoys a unique and enviable position as the only broadband services company with a significant presence in both Canada and the United States. The company has invested massively in fibre coaxial cable network infrastructure to the tune of CAD 450 million a year to improve and increase high-speed Internet connectivity, especially in rural and unserved areas, bringing new services and competitive choice to the communities it serves.

Revenue Mix

Business Segment                                              Geographical Segment                                                                 

Investment Rationale

• Government's Commitment to Improving Connectivity is likely to Benefit CCA: The company's operations are likely to be benefited by the recent launch of CAD 1.75 billion of Universal Broadband Fund by the Canada Broadband, which would help the Canadians to access to high-speed Internet from any place. This announcement is aligned with the company's goal and will enable it to pursue more infrastructure projects and reach more communities in Canada.

• Expanding Residential and Business Internet Service Customer Base: The company reported decent performance in the fourth quarter of FY20, with revenue increased 3.7% to CAD 605.2 million on a YoY basis. The increase was largely driven by 4.9% revenue growth in American broadband services on a constant currency basis on account of surge in both residential and business Internet service customers. Further, the Canadian broadband services revenue increased by 1.3% as a result of rate increases implemented during the first and the fourth quarter of fiscal 2020 for certain services.

• Successful U.S. Cable Expansion Strategy: The company sees strong organic growth opportunity in its largely non-metropolitan markets with the fragmented competition, and the company maintains one of the U.S. industry's highest adjusted EBITDA margin. Further, Florida expansion provides for a higher growth opportunity and stable cash flow.

• Strong free cash flow generation: The company free cash flow bolstered by 32.2% in the fourth quarter of 2020 to CAD 111.4 million because of higher adjusted EBITDA, combined with the decrease in the acquisition of property, plant and equipment. It indicates that the company is generating more cash than it used to run the company and reinvest to grow the business. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value as, without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. 

• Consistent Track Record of Dividend Payment: The company has a track record of consistent dividend payment over the past ten years, and at the last closing the stock was yielding approximately 2.6%, which is decent given the lower interest rate environment and significantly lower yields on the government's investment-grade bonds.

Source: Annual Report

• Industry Leading Return on Equity: The company’s return on equity for the financial year 2020 stood at ~16.8% against the industry median of 5.1%, which implies that the company is generating superior returns for its shareholders. Also, FY20 ROE improved 130 bps on YoY basis on account of increase in internet service customers both in Canada and America in the wake increasing work-from-home style amid COVID-19 outbreak. 

• Manageable Debt Proportion in the Balance Sheet: Despite a higher debt/equity ratio of 1.38x vs industry median of 1.24x, the company has adequate earnings to meet its debt obligations on time. The company’s interest coverage ratio stood at 4.09x, while Net Debt/EBITDA ratio stood at 2.44x. 

• Industry Leading Margin Profile in FY20: The company reported an industry leading margin profile in the financial year just gone by.

Source: Refinitiv (Thomson Reuters)

• Risk Associated with Investment: The company is exposed to a variety of risks ranging from intense competition, interest rate risk, forex risk and regulatory risks.

Financial Highlights: FY20

 Source: Company Annual Report

• Consolidated revenue increased by 2.2% to CAD 2.38 billion, driven by organic growth combined with the impact of the Thames Valley Communications acquisition completed on March 10, 2020 in the American broadband services segment, partly offset by a decrease in the Canadian broadband services segment.

Source: Annual Report.

• Adjusted EBITDA reached CAD 1.15 billion, up by 3.7% as a result of an increase in the American broadband services segment mainly as a result of organic growth and the impact of the Thames Valley Communications acquisition and an increase in the Canadian broadband services segment due to a decline in operating expenses.
• Profit for the year reached CAD 396.6 million, and the group generated free cash flow of CAD 455.4 million.
• Dividends paid to the shareholders increased by 10.5% to CAD 2.32 per share.
• Financial expenses for the FY20 decreased by 25.3% mainly due to lower interest rates and lowered outstanding debt on the First Lien Credit Facilities and the appreciation of the US dollar against the Canadian dollar compared to the prior year.
• Profit for the year from continuing operations attributable to owners of the Corporation increased by 10.4% on account of higher adjusted EBITDA and the decrease in financial expense mainly due to the CAD 22.9 million non-cash gain on debt modification resulting from the reduction of the interest rate by 0.25% in the second quarter of fiscal 2020.
• The group's cash flows from operating activities increased by 5.7%, driven by higher EBITDA and the decreases in financial expense and income taxes paid.
• Fiscal 2020 free cash flow in constant currency increased by 0.2%, under-achieving the Corporation's revised projections mainly because of higher-than-expected capital expenditures in the American broadband services segment.

Q4FY20 Financial Highlights

Source: Company Filing

• Revenue increased by 3.7% to CAD 605.2 million, driven by a 4.9% increase in the American broadband services revenue and 1.3% increase in Canadian broadband services revenue.
• Adjusted EBITDA increased by 6.9% to reach CAD 294.5 million, driven by 7.2% increase in the American broadband services adjusted EBITDA as a result of organic growth and the impact of the Thames Valley Communications acquisition, and 5.8% increase in the Canadian broadband services adjusted EBITDA driven by higher revenue combined with lower operating expenses mainly due to non-recurring elements of approximately CAD 4 million and lower marketing expense.
• Free cash flow increased by 32.2% to reach CAD 111.4 million as a result of higher adjusted EBITDA combined with the decrease in the acquisition of property, plant and equipment.
• The Board of Directors of Cogeco Communications declared a quarterly eligible dividend of CAD 0.64 per share compared to CAD 0.58 in the comparable quarter of fiscal 2019.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 64.06% of the total shareholding. Rogers Communications Inc and Letko, Brosseau & Associates Inc are among those holding maximum shares in the company at 33.17% and 9.66%, respectively. Institutional ownership in the company stood at 45.15%, and strategic ownership stood at 33.54%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Earnings

*Note: All forecasted figured have been taken from Thomson Reuters.

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The company exited the fiscal year 2020 with decent performance. The group has enhanced its service and product offering to meet and exceed customers’ expectations for distinctive experiences. The group continued the expansion of its 1 Gig offering while also enhancing the end-to-end digital experience. Despite the many challenges of the crisis, which still has the world in its grip, the company was able to maintain its financial discipline. More Importantly, Cogeco is profitable, with an adjusted EBITDA margin that is among the best in the industry, and dividends that have grown at a compounded annual rate of over 12% for the last five years. Also, the group has introduced Internet television (IPTV) entertainment system at the end of the fiscal year, and It would be rolled out progressively in fiscal 2021. Robust financial performance in 4Q 2020, along with the expectation low-single-digit % growth in revenue, adjusted EBITDA, and free cash flow for fiscal 2021 gives confidence in the group

Also, the group has benefited due to increased Incremental demand for its high-speed Internet product in the wake of covid-19 pandemic, however, pandemic has lowered the company’s advertising revenue, commercial revenue. The strong free cash generation by the company shows that the company is well positioned to company to pursue opportunities that enhance shareholder value.

Therefore, based on the above rationale and valuation, we have given a “Buy” recommendation at the closing price of CAD 97.86 on December 31, 2020 with a lower double-digit upside potential.

Technical Chart (as on December 31, 2020). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at January 4, 2021 price as well.

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