Consumers like to complain about Canada’s biggest telecom players, banks, railways and grocers, and how limited choice in this country is keeping prices higher than in much of the rest of the world.
This view resonates well beyond the humble citizen.
After Rogers Communications Inc. RCI-B-T announced a deal to acquire Shaw Communications Inc., in 2021, the Competition Bureau warned that the transaction would narrow the telecom field even further, leaving millions of consumers with higher cable and cellular costs, and worse service.
A more recent blockbuster deal – Royal Bank of Canada’s 2023 acquisition of HSBC Bank Canada – raised the suspicions of no less an authority than The Globe and Mail’s editorial board. From a competition standpoint, the board said, the loss of one bank “is one too many.”
Fair enough. Bank service charges and overdraft fees can infuriate consumers, and more choices could lower their temperature.
From the perspective of investors, though, Canada’s cozy network of oligopolies – in which a few players dominate one sector – can look very different. Slim competition can keep upstarts out and profits in, driving strong shareholder returns and attractive dividends over the long term.
“We have a handful of oligopolies that are able to fend off new entrants (whether regional or foreign) without needing to destroy profits for an extended period of time, or where we need a government financed solution,” Ian de Verteuil, head of portfolio strategy at CIBC Capital Markets, said in an e-mail.
Consider Canada’s six largest banks, known as the Big Six, which dominate domestic mortgages and hog most of the deposits in this country. Over the past 10 years, to the end of 2023, this elite group of profit-gushers has delivered a total return of 157 per cent, on average, with hefty dividends included.
The Big Six outperformed the broad S&P/TSX Composite Index by 48 percentage points over this period.
Railway stocks, which form another fine oligopoly, have performed even better. Canadian Pacific Kansas City Ltd. CP-T (formerly Canadian Pacific Railway before its merger with Kansas City Southern last year) and Canadian National Railway Co. CNR-T have delivered a total return of more than 240 per cent, on average, over the past 10 years.
That’s more than 130 percentage points better than the Canadian benchmark.
While railways posted stellar results as a group, one grocer – Loblaw Cos. Ltd. L-T – stands out with the top individual performance over the past decade, with an annualized gain of more than 16 per cent.
The strong performance among oligopolies is not a statistical quirk. Rather, it stems from the advantages of large companies that operate within mature sectors with high barriers to entry and an overall competitive environment that doesn’t shred profits.
Mr. de Verteuil found that these companies – in a research note, he focused on banks, railways, grocers and telecommunications providers – tended to deliver higher profitability. The stocks have generated returns that have easily beaten the S&P/TSX Composite Index over the past 30 years, and they’ve done it with lower volatility.
“A high level of industry concentration does not by itself enshrine consistently high profitability or long-term returns – but it certainly isn’t a drawback,” he said in a December report.
Canada has a lot of oligopolies, which now account for about a third of the S&P/TSX Composite in terms of their weighting.
The telecom sector is dominated by just three major players that have enraged – er, enrolled – 87 per cent of wireless subscribers. There are also three big grocers with a combined market share of nearly 60 per cent.
There are two major airlines and a couple of big pipelines. Even the number of large energy producers is shrinking to oligopoly standards, following years of consolidation in the Canadian oil patch.
“It’s a structure that has proven to be necessary because of our low population and geographic dispersion,” said Martin Pelletier, senior portfolio manager at Wellington-Altus Private Counsel, referring to oligopolies in general.
Another reason for the proliferation of oligopolies: The country’s economic growth is trailing its population growth, which is hardly an inviting trend for expanding multinational corporations that could offer meaningful competition here. Canadian regulations that support homegrown companies and restrict ownership to Canadians may deter the rest.
That means consumers will continue to grumble about their limited options, and investors can feast on attractive stocks.
Where to start looking? Here’s a short list of Canada’s best oligopolies, which have delivered consistent returns to investors and may benefit most from their exalted status.
The stock: Royal Bank of Canada (RY-T)
The payoff: The $14.9-billion profit that RBC generated in 2023 is yours. Well, some of it.
10-year return, annualized: 10.8 per cent.
There are many ways to pick a good bank stock, but simply sticking with Canada’s largest bank seems to be paying off nicely. Royal Bank of Canada’s total return over the past decade is 178 per cent, with dividends, which is 21 percentage points more than the Big Six average.
RBC has the largest market capitalization – the combined value of its outstanding shares – among the banks, and all Canadian companies, for that matter. It also has a deep reach within specific banking endeavours, such as capital markets, commercial banking and wealth management.
“It gets the greatest benefits of the oligopoly, just by sheer size,” said John Aiken, an analyst at Jefferies.
“Some of the fixed costs, in terms of compliance and investment in technology, get spread over a larger base. It allows RBC to provide services more efficiently and attract more clients, and it becomes a virtuous circle,” Mr. Aiken said.
Sure, smaller banks can, at times, generate better returns. National Bank of Canada, the smallest of the Big Six, has been on a tear over the past several years as it gobbles up the Quebec market. There are also plenty of online banks picking away at market share, without the need for expensive branches.
But RBC’s heft and diversification offers investors a relatively low-risk bet. When times are good, RBC will thrive; when times are bad, RBC delivers stability. It seems to work.
The stock: Canadian Pacific Kansas City Ltd. (CP-T)
The payoff: Worried about a new, low-cost railway undercutting the established players? Exactly.
10-year return, annualized: 13.5 per cent
You can understand why no one is building new freight railways in North America when you consider the cost of maintaining existing ones: an average of more than US$23-billion a year over the past five years, according to the Association of American Railroads.
Now imagine what it would cost to build a network from scratch.
Despite immense capital expenditures – along with fluctuating demand for hauling freight – the North America-wide oligopoly has thrived through consolidation, and a key reason is its efficiency.
“Since one rail car can carry the volume of approximately four trucks, and less fuel is consumed during the transportation of rail freight as opposed to other modes, the greater the distance, the more efficient rail is,” Adam Anderson, vice president at RSI Logistics, a transportation consultancy, said in a e-mail.
CPKC and CN have delivered similar returns over the past year, at 12.9 per cent and 11.6 per cent, respectively. They’re also valued similarly, at about $113-billion each.
But CPKC may enjoy operational advantages after CP’s merger with Kansas City Southern last year. The deal created a single line through Canada, the United States and Mexico, which promises to deliver double-digit profit growth from 2024 through 2028, with help from cost savings and share buybacks.
The stock: Telus Corp. (T-T)
The payoff: You won’t be enraged over service fees when they go into your pocket.
10-year return, annualized: 7.3 per cent
Canadian telecom stocks have been struggling over the past two years as rising interest rates weigh on the appeal of dividends, the established players plough big bucks into upgrading their fibre networks and Ottawa takes on the country’s high cellphone charges with tough talk.
Even so, these companies generate enormous profits, deliver attractive long-term returns and – best of all – beckon with dividend yields that look downright spectacular right now.
The appeal here is that businesses and consumers need connections no matter what the economy is doing, which gives the sector a defensive quality that has worked over the long term. According to CIBC’s numbers, the sector delivered a total average annual return of 11.4 per cent over the 30 years from 1989 to 2019, which is 3.2 percentage points better than the S&P/TSX Composite.
The sector’s performance has stumbled since then, which raises the question of whether this oligopoly’s best days are behind it.
More likely, the stocks are just temporarily cheap and beaten-up. Telus now trades at a lower price than in 2019, which has boosted its dividend yield to 6.7 per cent.
After the telecom reported its fourth quarter financial results, Cory O’Krainetz, an analyst at Vancouver-based investment manager Odlum Brown, said that costs associated with network upgrades and interest expenses weighed on profits. But these headwinds should fade.
“The underlying business is growing nicely, and cash flows are increasing at a strong pace,” Mr. O’Krainetz, said in a February note.
The stock: Loblaw Cos. Ltd. (L-T)
The payoff: Rising food prices might not sting so much.
10-year return, annualized: 16.1 per cent
Loblaw is much more than an upscale grocer. It also operates discount grocery-store brands, such as No Frills, the pharmacy chain Shoppers Drug Mart and T&T Supermarket, the Asian food retailer.
That gives the company a range that’s hard to beat. Loblaw also delivers efficiencies of scale, generates valuable data on the spending habits of members in its PC Optimum rewards program and has a lock on some of the best locations for its 2,400 stores nationwide.
“Loblaw has leading size and scope in Canadian retail and is increasingly leveraging this advantage in multiple ways. Loyalty is one key element, and it is apparent that this remains a key opportunity in 2024,” Mark Petrie, an analyst at CIBC Capital Markets, said in a note.
The grocery store oligopoly carries some baggage, though. There was that bread price-fixing scandal several years ago. And today, chief executives have been cast as villains as politicians look for someone to blame for soaring food-price inflation over the past couple of years.
The solution, according to the Competition Bureau, is to encourage online competitors, support independent grocers, open doors to international companies and ease property controls that can shut out new entrants.
Investors don’t seem to be too worried. Over the past two years, Loblaw’s share price has risen 22.6 per cent even as political headwinds grow stronger. Okay, that’s trailing the 30-per-cent spike in the price of butter, but it’s more the double the pace of food inflation.
Full disclosure: The author owns shares in Telus.
David Berman