Cogeco Inc. (CGO) Earnings Call Transcript & Summary

Good day, and welcome to Cogeco Inc. and Cogeco Communications, Inc. Fourth Quarter 2026 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrice Ouimet, Chief Financial Officer; Cogeco Inc. and Cogeco Communications Inc. Please go ahead, Mr. Ouimet.

Thank you. So good morning, and welcome to our fourth quarter results conference call. As usual, before we begin the call, I'd like to remind listeners that today's discussion will include estimates and other forward-looking information. We ask that you review the cautionary language in our press releases and MD&A issued yesterday as well as in our annual reports regarding the various risks, assumptions and uncertainties that can cause our actual results to differ. And with that, I'll pass the line to Fred Perron for opening remarks.

Merci, Patrice. Good morning, everyone. Our Canadian business continued to perform well in the quarter, with a reacceleration of our Internet customer growth, continued strong wireless sales and growing year-on-year adjusted EBITDA again this quarter. We were delighted to see our oxio digital brand be recognized as the most loved telecom brand in Canada. oxio sales are beating new internal records and we're just starting to scratch the surface of how big that business can become for us. We've continued to upgrade our Canadian high-speed Internet network, and now offer 1 gig and 2-gig residential speeds in approximately 95% and 50% of our Canadian footprint, respectively. In the U.S., we've observed an even further degradation in our competitive environment. This has resulted in elevated Internet customer losses in the quarter as we had indicated last time we spoke. And in light of these factors, we're introducing fiscal 2027 financial guidelines, which reflect lower year-on-year performance than last year. Rest assured that we're quite clear-eyed about the very challenging state of the U.S. market. We're nevertheless delivering significant operational improvements at Breezeline. In addition to wireless, we've built new sales channels, launched a new digital second brand and just a couple of months ago, launched a new over-the-top TV streaming solution. More broadly across the enterprise, we're executing well against what we can control and continue to hit the CapEx and OpEx reduction targets from our transformation program. We now have AI agents deployed across most key operational functions and that automation is really starting to bear fruit. Thanks to our disciplined execution, we delivered $554 million in free cash flow in fiscal 2026 for Cogeco Communications near the top end of our original guidance for the year and representing a 33% growth over 3 years. That strong free cash flow generation is enabling us to grow our dividend once again, albeit modestly for a 23rd consecutive year. At Cogeco Media, pleased with our strong radio audience engagement, which reached 4.6 million listeners per week. In summary, as we enter the third year of our 3-year transformation program, our priorities are to: first, keep growing wireless in both countries, which is pure upside for us; second, keep growing our oxio, while digital brands, leveraging the very high customer satisfaction these brands are getting in both Canada and the U.S.; and third, continue to reduce our OpEx and CapEx, including but not limited to, leveraging our rapid progress on AI in order to keep delivering superior free cash flow generation. And on that, I'll pass it over to Patrice for more details about our results. Patrice?

Thanks, Fred. So I'll highlight a few items from the quarter and then move on to our fiscal '27 guidelines and Q&A. So our Canadian business performed well in the fourth quarter with strong Internet customer additions and growing revenue year-on-year. We also had stronger-than-expected adjusted EBITDA which benefited from growing revenue, cost reductions and some year-end adjustments. In the U.S., the quarter was more challenging than expected due to higher Internet customer losses and elevated competitive pressures impacting revenue and adjusted EBITDA. During the quarter, we announced the launch of a partnership with [ DIRECTV]. An over-the-top streaming solution for the U.S. business. We expect this product to have positive impact on future adjusted EBITDA and free cash flow. It's, however, important to note that we will gradually see a negative impact on our video subscriber metrics, since we will not be counting [ DIRECTV ] in our disclosed subscribers. Our practice is to only account for company-owned brands and reported subscribers. It will also reduce revenue over time that we will only account for the earned commissions in revenue rather than the full video subscription. But as I mentioned, it will be positive for adjusted EBITDA and free cash flow going forward. The consolidated debt leverage ratio stood at 3.1 turns at the end of the fourth quarter versus 3.2 turns reported last quarter. During Q4, we refinanced maturing debt with a new $200 million Canadian tranche, and we repurchased USD 46 million of breezeline's Terminal B debt securities. We expect to continue to use excess cash to repay debt in the Canadian and U.S. borrowing structures over the coming quarters. As for free cash flow, we continue to deliver capital efficiencies throughout the year, which allowed us to grow free cash flow at Cogeco Communications by 7.3% for the full year on a constant currency basis. We also increased the dividend for both Cogeco Communications and Cogeco Inc. by 2%. In determining this percentage, our goal was to strike a balance between shareholder distributions and debt repayments. Now let's discuss the financial '27 guidelines, which we are introducing today. As a reminder, we provide our financial guidelines in constant currencies since foreign exchange rates can be volatile, and plus half of our revenue and adjusted EBITDA is generated in the U.S. dollars. Free cash flow is, however, much less impacted by FX rate movements. Cogeco Communications expects revenue to decrease by a low to mid-single-digit percentage compared to the prior year due to a combination of growth in the Canadian customer base offset by both pricing pressures and subscriber losses in the U.S. due to a highly competitive and promotional market. Adjusted EBITDA is anticipated to decrease by a mid- to high single-digit percentage compared to the prior year due to lower revenue from the elevated competition in the U.S. that is expected to persist throughout fiscal 2027. And this is partly offset by cost efficiencies as we progress through our 3-year transformation program. As for capital expenditures, we are expecting to spend between $425 million and $475 million driven by operational efficiencies and the near completion of many network expansion and upgrade projects. Free cash flow is expected to be between $500 million and $550 million since U.S. EBITDA pressures, higher financial expenses and higher income taxes are partially offset by capital efficiencies. For fiscal '27, we assume financial expenses to be in the range of $250 million and $300 million and our current income tax to be in the range of $30 million to $60 million. Finally, at Cogeco Inc., we have issued the same financial guidelines as Cogeco Communications with the exception of net capital expenditures and free cash flows, which are slightly higher. And now, Fred and I will be happy to take your questions.

[Operator Instructions]. Your first question is from Vince Valentini from TD Cowen.

A couple of things for me. One, the outlook for the Canadian segment in 2027. I mean, you finished the year strong on financials and Internet subscribers. You seem pretty confident in recent conference commentary that the pricing environment is as disciplined as it's been in a few years and you're still obviously quite bullish on the wireless traction and the oxio traction. That all sounds to me like you expect slightly positive revenue and EBITDA growth in Canada in 2027, but I don't see that in your official guidance or commentary. So if you can clarify that for us. And if it's not positive, is there something one-off you can point to? Are there still wireless start-up costs, for example, or anything else that are an unusual drag on EBITDA that we maybe should know about? So that's question one. I'll just throw my other 2 quickly for you, so you can think about them. Working capital seems unusually strong in both the fourth quarter and the full year what, $88 million inflow in fourth quarter and $138 million inflow in the full year '26. Is that just timing issues or maybe some of the rural subsidy stuff you've been doing and you're finally getting the subsidy payments in on a lag basis from the government or something else going on there? And would you expect that to be even remotely sustainable in '27, Patrice? And last, just a technical question, if you know it. on spectrum transfers, obviously, [ ISED ] has to approve anything. Do you know how finicky they are or how complicated it is to get approval for a subordination of your spectrum, if you're just basically leasing it to somebody, for example, if you want to lease it to a foreign satellite giant, would you have to go through [ IID ] approval? Or could you just do that at your leisure?

Vince, so I'll start with the order you asked them. So first of all, for the guidance, as you see, we have a range. Obviously, it's provided at a consolidated level and the range allows for over and underperformance at a consolidated level. So if we look at only by country, the commentary I could provide is that for Canada, we're expecting to be relatively stable during the year for revenue and EBITDA, and obviously, then there is a range around that. We did perform well last year. As part of that, there's different elements, there's pricing, there's the customer additions, which we're planning to continue to grow. We have our transformation program in there. There's a mix shift as well, where we have, over the years, a bit more focused on Internet product. And then mobility is picking up as well. So you take all this together, stability would be the way I would look at it for Canada. So your next question is on working capital. This one can be more volatile by quarter. What we expect for the coming year would be to be positive actually on working capital. probably not by a huge extent, but to some extent. And we do have some receivables that are related to subsidized builds, as you pointed out. Some of these contracts pay completely at the end once you're really done fully with a region. So we will collect some of that in the coming year and in fiscal '28 as well. So probably some slight positive movement on our generation on working capital.

Vince, it's Fred. On the third question, as you pointed out, [ ISED ] has a lot of discretion on approving both spectrum transfers and subordination. So your understanding is correct. As it relates to the unnamed U.S. satellite giant, I think they've said publicly that their wireless strategy for Canada, they're very different from the U.S. Our understanding is that they're not intending on building a full terrestrial wireless service in Canada. And for that reason, it would make that type of [ spectrum ] monetization for us less likely. However, there are other ways of monetizing our spectrum as we've discussed in the past.

Your next question is from Aravinda Galappatthige from Canaccord.

First one is on Canada. As was mentioned earlier, pretty good operating leverage, 3.5% EBITDA growth on much lower revenue growth. Maybe, Patrice, is there any other items that we need to be aware of that drove that operating leverage? Was there sort of more significant movement on the wireless side that perhaps exaggerated that. I wanted to understand that dynamic a little bit better.

Yes. So I would say if you look at only Q4, we had -- that's right a higher margin there. And that's why in the opening remarks, I mentioned higher than planned growth year-over-year, but I would not necessarily expect that it would be at that level in the future. That's why I was talking more about stability. We did have some one-timers that were positive in Canada in Q4, but it doesn't explain necessarily the full amount of it. So these are nonrecurring and it's normal at year-end, we typically have a bit more of those, and we had some negative ones in the U.S. But that being said, we've been performing well with the growth in the sub base, which has been helping in the results over the year, for sure. And that transformation has continued to pay off. And the transformation program helps with costs. It helps with capital expenditures as well. It helps with revenue, although the revenue piece, as we've always said, is a bit more in the third year. And once we're done with the third year, we'll want to pursue that program. So it's not necessarily going to and there, but it's going to be the end of our first phase of the transformation.

Yes. Aravinda, it's Fred. I would simply add. As Patrice said, there were some one-offs in Q4. So I wouldn't necessarily extrapolate, but as a longer-term trend going into next year, we had a bit of more end of promo. We got a bit of a bump from end of promo expiries in the previous year, which will not repeat to the same extent next year. And in an earlier answer, Patrice also alluded to the product mix shift and the customer mix shift. As we do more and more oxio, the Internet margin on oxio is comparable to the Internet margin on Cogeco, but we sell less TV, for example. So there's an impact from that as well.

Fred, and then maybe just a second one for you. On the U.S. business, we know a couple of years ago, you did consider a part of the footprint or explore the prospect of a divestiture there. Is there any sort of thought on maybe revisiting that idea? I realize sentiment is weaker and perhaps bids could even be harder to come by. But not all regions are the same. I was wondering if that's something that's sort of still on your desk or silo consideration given sort of the outlook at this point?

Sure. A couple of things. So first, as I said in the introductory remarks, we're very clear eyed about the challenging state of the U.S. market. So there's no magic thinking here about that. Secondly, we understand that many of you and many investors put very little value on our U.S. business when looking at the sum of the parts approach, so we understand as well. We're working hard doing the best we can to improve the performance of the business operationally. We launched a second brand, similar to oxio in Canada. Earlier this week, we've announced that we're expanding that brand to 2 more states and in 2 weeks, we'll announce 2 more states. So by then, we will offer that branded 70% of our U.S. footprint. We launched a [ DIRECTV ] product, and we're building new sales channels as well. So we're doing everything we can on that front. As it relates to your question, we always seek the best possible way to create shareholder value. We don't need necessarily to think about it in black and white all the time. There's a variety of colors in between, but we always seek the best way to create shareholder value.

And last question, on the dividend increase, maybe just your thoughts around -- I mean it's a considerable step down from the high single-digit increases that you were implementing considering the free cash flow is still very strong. Your CapEx is stepping down. It's a very, very low dividend payout ratio. Maybe your thought process about dropping that to 2%, and I'll pass the line.

Yes. It's a difficult decision to make on where to land with this, whether last year, we have done -- we always knew we wouldn't necessarily stay at a very high level compared to what peers are doing, let's say, annually because ultimately, you need to grow the free cash flow at the same level to get to a similar ratio. What we wanted to do is to grow the dividend because we do believe in growing the dividend as we've done for many years now. At this point, obviously, the business has seen some more volatility as well. We're focusing more of the dollars on debt repayment. And I'm talking more of the U.S. business as we integrate it into the consolidated numbers. And we thought that was a reasonable place. Obviously, our dividend yield is quite high right now when you look at the stock price. It's not necessarily the factor we're using mainly to make that decision, but it's something we look at as well. And we will have to see in the future. We're not necessarily married to 1 percentage going forward, but we thought it was the appropriate thing to do given where we are and the guidance we're giving for next year.

Your next question is from Drew McReynolds from RBC.

Yes. Thanks maybe for you starting out, Patrice, on the increase in financing expenses in the guidance for fiscal 2027. Is that just a rate interest rate higher? Or is there kind of anything else just in that guidance?

Yes. So there's a mix of things. One of them is rate. So we have a portion of our borrowings, which is floating. The majority is fixed, but we have a portion of slowing, especially related to the U.S. business and the rates have been going up in the U.S. So that's one element. There's another element is the refinancing we did in Canada. It's not large, but [indiscernible] a higher rate than the previous tranche. We had also some nonrecurring gains is last year and the financial expense that came through purchases we did of debt on the market. So we've assumed we typically don't project a number for that this year. And then we've assumed some costs related to an upcoming refinancing we'll have to do on a tranche in the U.S. So I would say it's a mix of these 4 elements.

Okay. Yes, that's very helpful. Maybe secondly, on the margin outlook for American Broadband. Given the underlying pressure you've done kind of wonderful things on margins over the last couple of years. But just implied in your fiscal 2027 guidance, it seems to kind of imply a step down here. Is that all related to maybe a deteriorating TV margin, just given what you're trying to do with some of the initiatives? Or are there other dynamics here on the margin front?

Yes. So when you look at the U.S. business, obviously, given the competition, you've seen some reduction in the cost base -- sorry, not the cost, the subscriber base. So at the gross margin, which is not the number you see, it doesn't change anything. But at the net margins or the EBITDA margin, we have some fixed costs, so that plays into it. When we have a mix shift with less TV, actually, this helps, that goes the other way. This helps with the margin. But there is some pricing pressure. So when we acquire new customers, or for customers that we have, generally, there's been some pressure, not just for us, for other players as well. And we have to absorb this. So either we take it in the EBITDA, which impacts the margin negatively or we offset it with some cost reductions, which we're also doing through the transformation. Given the intensity of competition today in the U.S., we're doing all these things, but the level of cost reductions is not enough to offset the pressure, which -- the pressure on revenue, which basically pressurizes the EBITDA margin.

Okay. Okay. Yes, makes sense. And last one for me. In your deck, you talked about kind of [indiscernible] being in a pretty inflection stage. Just wondering in fiscal 2027, does that kind of go post inflection? Or is that something kind of for fiscal 2028?

Drew, it's Fred. A couple of things on [indiscernible] and then I'll answer your question. So a couple of things -- reasons to feel good about that initiative. First, customer satisfaction is extremely high the subscribers we've connected so far. We get 4.9 stars out of 5 on Google is as high as what we see on oxio in Canada and one of the highest I've ever seen in telecom around the world. So we feel good about that. The margin on those subscribers is also as high, if not slightly higher than the margin that we get on the breezeline brand. Now on volume and penetration, which is your question, we're still very much pre inflection. It's hard to know for sure when the inflection in the S-curve will happen, but it will happen. These things usually do follow an S curve. As it relates to the outlook for the year, I would say we're not yet expecting a massive inflection in our forecast, but that's hard to call. And if the massive inflection does happen in the year, then we'll be positively surprised.

Your next question is from Jerome Dubreuil from Desjardins Securities.

Just one for me. On leverage, obviously, your level of distribution in terms of the dividend is still very manageable. I have it about 1/3 of your free cash flow for the next year, so enables quite a bit of debt repayment. However, what's going on with the EBITDA growth next year, do you think you can still deleverage the net debt-to-EBITDA basis in 2027?

Yes. So we finished the year with 3.1 turns of debt-to-EBITDA, the consolidated level we -- using the guidance we provided, let's at the midpoint, you get to a small reduction. So you'd be at around 3x by year-end.

Question is from Matthew Griffiths from Bank of America.