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Morningstar | Rogers Produces Yet Another Outstanding Quarter, but We're Still Wary of the Stock at Current Levels

Narrow-moat Rogers added to its string of excellent quarters during the third quarter, highlighted by strong wireless subscriber additions and impressive EBITDA margin expansion. Maintaining performance like this would make our CAD 57 fair value estimate look too low, but we fear this may be closer to a pinnacle rather than a sustainable pace for Rogers. We expect subscriber additions to decline a bit after 2018, and we are concerned by the level of competition Rogers is up against. While we will likely raise our fair value estimate a few dollars to account for the strong quarter, time value of money, and slightly higher margins over our forecast than we previously projected, we still see the stock as a bit overvalued.

Most impressive to us was the margin expansion Rogers produced in the face of a competitive environment that now includes more legitimate threats from Bell in wireline and Shaw in wireless. Adjusted EBITDA margin was up 160 basis points, including 90 basis points in wireless and 160 basis points in cable. We attribute this to both stronger average billings per user and the spoils of more efficient customer service, which reduce costly service calls and home visits. Management expects that over time margins can expand even further. While we believe something close to current levels is sustainable, we are not convinced margins will expand much more due to competition that will contain pricing power.

Wireless metrics remain historically strong. The firm added 124,000 net postpaid subscribers and kept postpaid churn below 1.1% for the third straight quarter. Average billings per user, or ABPU, grew nearly 4% year over year. We think Canadian wireless industry growth has provided a tailwind to all companies, and on an annual basis we don't expect it will get better for Rogers than the over 400,000 postpaid subscribers we expect it to add this year. We also expect churn to rise and ABPU growth to moderate in the face of greater competition.

Recent subscriber trends continued in Rogers' cable business. The firm again added several thousand Internet customers (35,000, net) and lost a few thousand TV customers (9,000, net). We expect Internet trends to continue but slow over the next few years. We forecast net Internet additions in 2018 to be similar to last year's 95,000 gain. We think additions will then gradually drop to about 50,000-60,000 by 2022, largely because we think Rogers finally faces legitimate competition from Bell, which has rolled out fiber to the home, or FTTH, in many areas. We expect Rogers to reverse the trend of TV customer losses by 2019, as it introduces its superior IgniteTV offering, which we think will also lead to a bit of ABPU growth after flat to negative rates since 2015.

We think required capital spending is one of the bigger headwinds to Rogers' valuation relative to Telus and BCE. In our view, Rogers has underinvested in wireless the last couple years. Wireless capital spending has increased a bit in 2018, and we expect Rogers will have to maintain this higher level to keep its network closer to the quality of Telus and BCE, which have efficiencies from their network-sharing agreement. Rogers also expects especially high cable capital expenditures in the near term as it brings fiber deeper into its network, again resulting in levels higher than Telus and BCE, which we expect have already undertaken the bulk of their FTTH spending.