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Morningstar | Wireless Stands Out in Shaw's Fiscal Q1, Consistent With Our Long-Term View; Maintaining CAD 26 FVE

Shaw's nascent wireless business is making strides and tracking what we think is a long path to becoming a legitimate fourth national competitor in the Canadian market. With another strong quarter of postpaid net additions, double-digit ABPU (average billings per user) growth, and churn (which it disclosed for the first time) lower than we anticipated, the company's execution is excellent in our view. However, the wireline business—the source of the firm's narrow moat—is plodding along, and we are disappointed the company continues shedding consumer cable customers. With the two segments following the course we've projected, and with minor adjustments to our near-term forecast offsetting each other, we are maintaining our CAD 26 fair value estimate, leaving shares fairly valued.

While wireline, which accounts for 80% of sales and 90% of operating income, exhibited nearly no year-over-year revenue growth in the quarter (Shaw's 9% top-line growth was driven almost exclusively by wireless), it produced substantial margin expansion, as the voluntary departure program the firm initiated last year is leading to greater expense reduction than we anticipated. Wireline margins, at over 46%, were up more than 5 full percentage points from the year-ago period and were solely responsible for companywide operating income increasing 14%.

An uptick in consumer wireline broadband customers was a positive development after two straight quarters of sequential declines, but the firm lost an additional 24,000 consumer cable customers after losing almost 150,000 customers last year (its base now stands at about 1.5 million). We expected Shaw to face tougher wireline competition, given Telus' fiber to the home initiative, but we thought its BlueSky TV offering, based on Comcast technology, would make its cable offering more attractive. We are yet to see results. We now don't expect cable customer losses to cease until 2020, after which we project it to remain relatively flat.

Wireless results exceeded our expectations on nearly every metric. Our thesis is premised on the firm making major gains over time, but we thought Shaw would have to improve its network more before it put up ABPU and churn results like we saw this quarter. We expected the 700 MHz spectrum Shaw is rolling out would be a difference maker, but with that rollout only 25% complete, the firm put up churn of 1.28% and grew ABPU by 12% year over year, to CAD 42. While both metrics still trail industry averages by a substantial margin, we expect the gaps to close as Shaw's relatively inferior network continues to improve. We project about 8% annual ABPU growth through 2023, while churn gradually falls to about 1.1%. With 86,000 postpaid net additions in the quarter, we now project a total of nearly 300,000 for the full year. Despite most holiday sales not occurring until the second quarter, we expect the pace to slow a bit, given the spike the Canadian industry has seen in the last year and management's commentary that the environment seems less active this year than last.

The only disappointment we saw in the wireless segment was operating margin, which was 16.5%. However, that metric has been volatile (last year's range was 12.4% to 26.2%); it is typically depressed during quarters with strong net additions; and we don't think it is an especially important metric as the firm focuses on expanding its share of the market against stronger competitors. Still, we are reducing our full-year projection by about 2 percentage points, to 20%. We expect it will expand significantly as the firm gains share--we project it to be closer to 30% by 2023.