Strategy

Cogeco Inc. (TSX: CGO) is executing a three-year strategic transformation (20242027) focused on increasing agility, efficiency, and growth. The company is streamlining operations by merging its U.S. and Canadian telecom teams into a unified North American structure, enhancing cross-border collaboration and creating centralized hubs for digital innovation and advanced analytics.

A key growth driver is its planned entry into the Canadian wireless market in 2025 through the MVNO framework, complementing ongoing U.S. wireless expansion in regions like Ohio, where it aims to scale sales and optimize high-margin offerings. MVNO stands for Mobile Virtual Network Operator. It is a company that provides mobile phone services but does not own the wireless infrastructure that it uses. It plans to bundle wireless service with its wireline service.

Cogeco is prioritizing digital transformation, modernizing networks, digitizing customer interactions, and leveraging analytics to improve decision-making while advancing rural connectivity projects. Financially, the company targets $100M+ in annual synergies through cost efficiencies and operational streamlining, alongside disciplined capital allocation to support EBITDA margin expansion and sustainable free cash flow. Customer-centric initiatives remain central, with a focus on boosting internet subscriber growth in Canada (via Cogeco and Oxio brands), improving U.S. retention, and enhancing service delivery. Despite near-term capital expenditures, By balancing innovation, market expansion, and shareholder returns, Cogeco aims to solidify its position as a small but nimble competitor in North America's evolving telecom sector.

Debt is manageable

Cogeco does carry a large debt load (Debt/Equity is 6.04). Telecom is a capital intensive business especially now as it rolls out Fiber to the Premises (FTTP). It is also progressing its wireless service selectively in its service area in the US and soon Canada. However management is predicting that capital expenditure will decline in the near future and this will increase free cash flow. Debt/EBITDA is fair at 3.72. Cogeco plans to bring this to 3.0. Interest coverage (operating income/ interest expense) is 2.76. Given stable operating cash flow this debt is not alarming.

Cogeco Inc. holds debt, and its subsidiary, Cogeco Communications Inc. (CCA), also has its own debt. While the debt of Cogeco Communications Inc. is non-recourse to Cogeco Inc., Cogeco Inc. includes CCA's debt in its leverage calculations.

Excellent Dividend

Cogeco raised its quarterly dividend by 8.0% to $0.922/share, signaling confidence in cash flow stability. Cogeco has been paying dividend since 1989 with no dividend reduction in the last 19 years. The company has a forward dividend yield of 6.69%. The company's recent payout ratio was only 0.23, so it has good capacity to expand its dividend. 5 year dividend growth rate is 14.9%.

Cogeco's dividend metrics compares well against it North American peers.

Valuation is Undervalued

The chart below illustrates Cogeco's share price in Canadian dollars over the past five years, compared to the median justified price ratios derived from historical price multiples (PE Ratio, PS Ratio, PB Ratio, and Price-to-Free-Cash-Flow). The chart clearly demonstrates a significant discount in Cogeco's share price relative to recent multiples.

TSX:CGO Data by GuruFocus

Comparative Analysis

• Warning! GuruFocus has detected 6 Warning Signs with TSX:CGO.

The following table compares selected metrics for Cogeco (and its subsidiary Cogeco Communications) with its Canadian peers and a couple of US telecom companies. Cogeco has lower PE and EV/EBITDA compared to this set. Note also the higher 5-year EBITDA growth rate.

Large Margin of Safety

Gurufocus DCF Calculator (below) also indicates a large margin of safety even after using a conservative growth rate of 3% and a discount rate of 10%.

High Owner Earnings

Owner Earnings is a cash flow concept introduced by Warren Buffett (Trades, Portfolio) in his 1986 Berkshire Hathaway company letter to shareholders. At this time that companies were not required to produce a cash flow statement nor were stock based compensation such a big concern. Buffet's formulations of owners earnings removes non-cash distortions from earnings to focuses the investors attention on how much cash they are getting as partial owners of the company at the end of the period. Buffet explained Owners Earnings as follows: Owner Earnings = (a) Net Income plus (b) depreciation, depletion, amortization, and other non-cash charges minus (c) average annual maintenance capital expenditures. Owners Earnings is similar to free cash flow, but I think a superior metric because it starts from net earnings, so takes stock-based compensation as well as maintenance capex into account. Unlike Free Cash Flow, owner's earnings includes stock based compensation and maintenance capex which can be a significant expense for some companies.

The following table summarizes Cogeco's owner earnings over the last 10 years. Note the owner yield is the reciprocal of price to owner earnings. Another way to think about this is that investors can payback an investment in Cogeco stock in less than 4 years of owner earnings.

Buffett's Equity Bond Method of Valuation

Warren Buffett (Trades, Portfolio)'s equity bond method is a mental model for valuing stocks by comparing them to bonds, focusing on the stock's earnings yield as if it were a bond's yield. The approach involves treating a stock as if it pays out its earnings as a coupon, with the earnings yield calculated by dividing earnings per share (EPS) by the share price. For example, if a company has an EPS of $5 and a share price of $100, the earnings yield is 5%. Investors then compare this yield to the yield on a risk-free government bond, such as a US Treasury. If the stock's earnings yield is higher, and the company is of high quality with good growth prospects, the stock may be undervalued or a better investment than the bond. Unlike bonds, which pay a fixed coupon, a stock's earnings can grow over time, meaning the yield on your original investment can increase as the company's earnings grow, compounding your returns.

Buffett uses this method to identify companies that can compound returns over many years, focusing on high-quality businesses with durable competitive advantages and the ability to reinvest earnings at high rates of return. However, the equity bond method is not a standalone tool; Buffett also considers other factors such as return on equity, debt levels, and the company's competitive moat. In summary, the equity bond method reframes stock investing as buying a bond with a variable, potentially growing yield. By comparing a stock's earnings yield to bond yields and factoring in the company's growth prospects, investors can make more rational, businesslike decisions about where to allocate capital for the best long-term returns.

Economic Moat

While I am not confident that Cogeco has an economic moat which would attract an investor like Buffet it does have an enormous earnings yield which has been in place for a while. Earning yield is the reciprocal of the PE Ratio expressed as a percentage. Cogeco's PE Ratio (without NRI, or Non-recurring items) is 3.53. This works out to an earnings yield of 28.3%. Cogeco's Shiller PE is 7.13. (Shiller PE also known as E10 is a concept invented by Prof. Robert Shiller. E10 is the average of the inflation adjusted earnings of a company over the past 10 years.) Converting Shiller PE to Shiller Earnings yield we get 14.02%. Both these earnings yield are far above the 10 years US Treasury bond yield which is currently at 4.5% and the analogous Canada 10 year bond yield is 3.46%. This would indicate an healthy margin of safety. Cogeco's 10-year median Return on Equity (ROE%) is quite good at about 17%. All in all, while it does not appear that Cogeco has an economic moat The company's financial stability and regional strength are positives, but they do not translate into the kind of durable, structural advantages that would protect it from competition over the long term. Investors should view Cogeco as a solid, income-generating telecom stock, but not as a moat-protected business. It is a capital intensive business subject to high competition.

Conclusion

Cogeco appears to be a solid low growth income stock which pays a large and reliable dividend of 6.24%. It is also buying back stock with 3 year buyback ratio of 15.9. The company is family controlled and seem to have good stewardship.

Earnings per share grew by over 28% over the past year and 6.8% CAGR over the past 10 years. Debt is high but the company is working to bring it down. It is Trading at good value compared to peers and industry.

This article first appeared on GuruFocus.