BCE (TSX:BCE) has been a stalwart for Canadian dividend investors for decades. However, with its stock down 23% in the past year, there is rising concern that this investment may not be as good as it seems.
In just one year, BCE’s dividend yield has risen from 6.3% to a stunning 8.5%. That is substantially above its 10-year mean of 5.59%. Certainly, that big dividend yield on a Canadian large-cap staple could seem very attractive. The yield itself may tempt income-focused investors to jump in. However, investors do need to be cautious.
Don’t be deceived by TSX stocks with big dividend yields!
A stock should never be considered a good investment just because it has a high dividend yield. In fact, a large yield should be a warning sign.
Whenever a stock trades with a dividend yield over 7%, there is generally a reason for it. It means the market is factoring considerable risks on the horizon for that business.
To contemplate higher operational or financial risks, the market pushes the stock price down. The dividend yield must rise to compensate investors for this elevated risk.
Stocks (especially those with market capitalizations over $40 billion) don’t normally trade with massive dividend yields unless they have some major issues. BCE is no exception.
BCE stock is facing a plethora of headwinds
To keep up with an increasingly competitive telecommunications market, BCE has been investing in an aggressive infrastructure buildout plan. This has been essential to support its customer growth targets.
However, BCE has had to finance this with a very extensive amount of debt. Since 2019, net debt has increased by 35% to $34 billion. In that time, net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) has increased from five times to 7.2 times.
Ballooning debt charges are impacting earnings
This debt increase was okay when interest rates were 2-3%. However, when they are 6-7%, it starts to put strain on the balance sheet and profitability. The problem is EBITDA growth has not been commensurate with its growing balance sheet debt.
In fact, since 2019, EBITDA has only increased by 2.2%. Earnings per share have declined by 44%, while interest expenses have increased 37.5% in the same period. Its infrastructure investments have yet to pay off in strong cash flow growth.
Competition is pushing down telecom pricing
That is only the beginning of its headwinds. The recent Rogers-Shaw merger is increasing competition, and cellular plans are starting to decline.
BCE’s media division has been weak for some time. This segment has been a drag on earnings for several years. It recently implemented several layoffs and became a forced seller of several media assets at unattractive valuations.
Lastly, the federal government has its target on telecommunication companies. Regulations and new legislation are making telecom investments much less profitable while also boosting competition.
Its dividend is not sustainable at current levels
Given recent weakness in revenue and earnings, the company’s current dividend per share is not even sustained by the spare cash it generates. In fact, its free cash flow payout ratio is 111%. This means it is paying out 10% more cash in dividends than it is generating from its business.
The excess payout is only being afforded by the amount of leverage it has taken to support its dividend. This is not a sustainable program. It makes very little sense why BCE increased its dividend by 3% in 2023 when it would further strain its balance sheet.
Is BCE a buy for its big yield?
With these challenging dynamics, BCE is a stock most investors (especially retirees) should just avoid at the present. Even though its valuation has declined, and its dividend yield has soared, the risks are just not worth the reward at the present time.
