What is your outlook for BCE Inc. BCE-T in light of your colleague David Milstead’s recent column about the company’s high payout ratio and unsustainability of its dividend?
Well, I’m not as comfortable about BCE’s dividend as I was before I read the article. But I’m not about to sell my BCE shares, either – not yet, anyway.
BCE is indeed paying out more in dividends than it generates in free cash flow (FCF), and this cannot continue forever. The big question is whether the company can gradually bring its payout ratio down to a more sustainable level by increasing earnings and cash flow, cutting capital spending and perhaps throttling back its dividend growth, or whether it will have to resort to a dividend cut to get there.
I don’t have the answer. I suspect BCE doesn’t even know, given the many variables at play, including interest rates, regulatory policy and the performance of its myriad businesses, which include wireless, internet, TV, home security, media, advertising and cloud services.
But I can offer an educated guess or two.
While it is possible that BCE could eventually cut its dividend if its financials don’t improve, I don’t believe such a decision is imminent. This is a large company with lots of financial levers it can pull. What’s more, based on its stable credit ratings BCE does not appear to be in any danger of losing its investment grade status, which is often the impetus for a company to slash its payout.
I’m not alone in my view that BCE’s dividend is not in any immediate jeopardy.
“We believe BCE’s dividend is safe,” Jerome Dubreuil, an analyst with Desjardins Capital Markets, said in a note after BCE’s fourth-quarter results in February.
However, before you start licking your chops at BCE’s roughly 8-per-cent yield – which comes courtesy of a steep drop in its share price over the past couple of years – consider what Mr. Dubreuil said next: “The high payout of FCF limits future distribution increases and makes it more difficult for the company to invest in certain projects.”
Investors have already gotten a taste of how the future may unfold. With BCE’s 2024 free cash flow guidance coming in well below expectations – reflecting higher interest costs, hefty charges for its recently announced restructuring and adjustments to working capital – the company boosted its dividend by just 3.1 per cent in February, down from consecutive annual increases of more than 5 per cent for more than a decade.
As Mark Rosen, an analyst with Accountability Research Corp., put it in a recent note: “The board finally succumbed to reality (somewhat).”
Even though I’m a fan of dividend growth, increases should be supported by growing earnings and cash flow. That’s not been the case with BCE. Slowing the rate of dividend growth further, or even pausing hikes altogether, would be the prudent thing to do.
As Mr. Rosen sees it, BCE got itself into this predicament. Over the past 15 years, the company’s debt-to-equity ratio – a measure of financial leverage – has increased from 59 per cent to 151 per cent, he said. “No matter how you view it, the dividend increases have been funded by an increasing debt load. This largely explains the flat share price return for BCE over the past nine-plus years, in our opinion,” he said.
Still, some analysts see the dividend continuing to grow. Mr. Dubreuil, for example, is modelling dividend hikes of 3 per cent in each of the next two years, yet he still expects BCE’s payout ratio to fall to 100 per cent in 2025 and 95 per cent in 2026, down from an estimated 118 per cent of FCF in 2024.
Not all analysts are as sanguine. As Mr. Milstead pointed out, some analysts take issue with how BCE measures FCF, and their payout ratio forecasts are therefore less optimistic. Specifically, if one deducts hundreds of millions of dollars in capital lease payments from BCE’s own FCF guidance, its payout ratio in 2024 would range from 161 per cent to 183 per cent of FCF, Desmond Lau, an analyst with Veritas Investment Research, said in a note.
“Overall, we don’t understand the purpose of the dividend increase, as it only further increases the payout ratio,” Mr. Lau said. Citing the drop in BCE’s share price after the results, he added that “investors are also not rewarding the company for the dividend hike.”
The shares have lost more ground since then, closing Friday at $49.31 on the Toronto Stock Exchange.
But here’s the silver lining: BCE’s stock, which has skidded about 33 per cent from its 2022 high, is now trading below Mr. Lau’s intrinsic value estimate of $53 a share. It’s also trading below Mr. Rosen’s price target of $51, which is (tied for) the lowest on the Street, according to 16 analysts surveyed by Refinitiv. So, one could argue that, despite legitimate questions about the dividend’s sustainability, the shares still offer reasonable value at their current price.
With all of that said, for now I’m planning to hold BCE both personally and in my model Yield Hog Dividend Growth Portfolio, although I will be putting it on a short leash. My positions are relatively small, but if the stock accounted for a larger proportion of my portfolio, I might consider trimming back to control my risk. (View the model portfolio online at tgam.ca/dividend-portfolio).
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.