Cogeco Communications Inc (TSX: CCA) is the second-largest cable operator in Québec and Ontario and the ninth largest in the United States. The group 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

• Strong Canada Cable Operations: The company is offering the fastest internet speed in a large portion of the company’s footprint. Further, the operation is generating strong free cash flow, with industry leading EBITDA margin. The company is well positioned to partner with governments to expand connectivity in underserved and unserved areas. 

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

• Solid First-half Performance in FY21: For the first six months of fiscal 2021, revenue increased by 6.8% resulting from: a) growth of 7.6% in the American broadband services segment; and b) an increase of 6.2% in the Canadian broadband services segment, mainly from revenue generated from the DERYtelecom acquisition completed on December 14, 2020. For the first six months of fiscal 2021, adjusted EBITDA increased by 10.5%, and free cash flow increased by 24.3% mainly due to the following: a) higher adjusted EBITDA; and b) the decrease in financial expense, when excluding the fiscal 2020 non-cash gain on debt modification of CAD 22.9 million; partly offset by the increase in current income taxes.

Source: Company Presentation

• Lowering Capital Intensity Ratio: For the second quarter and the first six months of fiscal 2021, capital intensity reached 18.2% and 18.5% compared to 18.9% and 19.8% for the same periods of the prior year. Capital intensity decreases for both periods are explained mainly because of revenue growth in both the Canadian broadband services and American broadband services segments. However, for companies in the same industry and following similar business model and production processes, the company with lower capital intensity is better because it generates more revenue using fewer assets.

• Steady Annual Dividend Growth: Sustained free cash flow generation has allowed the group to pursue growth objectives while returning capital to shareholders. At the last traded price, CCA shares are yielding ~2.2%, which is relatively higher compared to the risk-free rate on the 10-Year Canadian Government Bond of 1.56%. Also, the group has a consistent track record of dividend payment over the past 10-years and delivering a CAGR of 10% in dividend payment since 2017.

Source: Company Presentation

• Industry Leading Margin Profile: The group reported industry leading margin profile, which reflects the strong competitive advantage of the company over the peers, and the efficiency of the management to outlast average industry profitability and deliver a relatively higher return to the shareholders.

Source: Refinitiv (Thomson Reuters)

• Risk Associated to Investment: The company is exposed to a variety of risks ranging from intense competition, interest rate risk, forex risk and regulatory risks. Also, intense competition among internet service providers may weigh on the margin and profitability.

Financial Highlights: Q2FY21

Source: Company Filing

• For the second quarter of fiscal 2021, revenue increased by 8.2%, driven by the growth of 7.6% in the American broadband services segment and an increase of 6.2% in the Canadian broadband services segment, mainly from revenue generated from the DERYtelecom acquisition completed on December 14, 2020.
• Adjusted EBITDA for the second quarter of FY21 increased by 10.5%, primarily driven by an increase of 11.3% in the American broadband services segment, mainly resulting from revenue growth and the impact of the Thames Valley Communications acquisition, combined with the timing of certain sales and marketing initiatives deferred to the second half of the year. This was further supported by an increase of 10.1% in the Canadian broadband services segment, mainly resulting from revenue growth and the impact of the DERYtelecom acquisition, combined with the timing of certain sales and marketing initiatives deferred to the second half of the year; partly offset by higher operating costs.
• Free Cash Flow jumped by 14.5% to CAD 142.768 million against CAD 125.06 million reported in the same period of the previous financial year, driven by higher adjusted EBITDA and the decrease in financial expenses.
• Fiscal 2021 second-quarter profit for the period decreased by 3.0%, as a result of higher financial expense, mainly due to CAD 22.9 million non-cash gain on debt modification recognized during the second quarter of fiscal 2020, and higher income taxes expense; partly offset by higher adjusted EBITDA.
• During the second quarter of fiscal 2021, a quarterly eligible dividend of CAD 0.64 per share was paid to the holders of multiple and subordinate voting shares, totaling CAD 30.5 million, compared to a quarterly eligible dividend of CAD 0.58 per share or CAD 28.3 million, in the second quarter of fiscal 2020.
• For the second quarter of fiscal 2021, Internet service customers net additions amounted to 6,383, compared to 5,770 for the same periods of the prior year. The net additions for the period were mainly resulting from: a) growth in the residential sector primarily resulting from the increased demand for highspeed offerings due to customers spending more time at home for work, online education and entertainment purposes in the context of the COVID-19 pandemic; b) increased bulk residential customers' activations related to the Florida expansion initiatives, and c) growth in the commercial sector.

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, and Fidelity Management & Research Company LLC are among those holding maximum shares in the company at 33.23% and 6.59%. Institutional Ownership in the company stood at 45.15% and strategic ownership stood at 33.54%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA Based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The group has enhanced its services and product offerings to meet and exceed customers’ expectations for distinctive experiences. The group also continued with the expansion of its 1 Gig offering while also enhancing the end-to-end digital experience. Also, the group has introduced an Internet television (IPTV) entertainment system at the end of the fiscal year, and It will be rolled out progressively in fiscal 2021. The overall product performance and reliability were enhanced following network investments for Gigabit Internet. CCA has grown its product offerings, launching the TV Online app and HBO Max, as well as adding Showtime Anytime, YouTube Kids and Amazon Prime to the TiVo platform.

Further, the company reported decent performance in the first half of 2021, with revenue increased by 6.8%, adjusted EBITDA increased by 10.5% and free cash flow increased by 24.3%, which implies a solid performance of the company. Moreover, the company is having an industry-leading margin profile and generating a higher return for its shareholders with a TTM ROE of ~16%.

Also, the company has the lowest capital intensity ratio that implies the company is generating more revenue using fewer assets.

Therefore, based on the above rationale and valuation, we suggest a “Buy” recommendation at the closing price of CAD 116.75 as of April 30, 2021.

Technical Price Chart (as on April 30, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at May 3, 2021 price as well.

Disclaimer

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