This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the worst ...
Is Telefonica (NYSE: TEF  ) the worst investment on the planet? Maybe not, but according to analysts at Bernstein this week, the Spanish telecom giant pretty darn close.

Yesterday, Bernstein took a hammer to Telefonica, downgrading the stock to "underperform" (that's "vender" in Spanish). Investors mostly shrugged off the warning, and the shares only lost a nickel in value after the downgrade. But who's got the better argument here -- is Bernstein right to be worried, or are investors just whistling past Telefonica's graveyard?

Telefonica looks cheap
After all, if you just look at the numbers, Telefonica looks a lot more like the kind of stock you should be buying, than one you should be vender-ing. Telefonica:

  • Costs barely more than 10 times earnings.
  • Generates much more free cash flow ($8.6 billion in the past 12 months) than it reports as GAAP "net income" ($5.5 billion).
  • Pays its shareholders an annual dividend yield of either 8.5% (according to Yahoo! Finance), or 15.6% (S&P Capital IQ).
  • And according to Wall Street, is growing its profits at a healthy 12.5% annual clip.

What could possibly be wrong with all of that? What could possibly justify slapping a "sell" rating on Telefonica?

Here's what: In three parts
You know the old saying about there being lies, damned lies, and statistics? Well, that seems especially true in the case of Telefonica. Let's start with that last number -- the growth rate. Wall Street may believe that Telefonica can maintain 12.5% annual growth over the next five years. After all, while technically a "Spanish" telecom, the Spanish share of Telefonica's revenues has been shrinking for years.

The company actually generates more revenue in Latin America than it does in Spain, and does nearly as much business elsewhere in Europe, as it does in its home market. This diversity of operation has helped Telefonica sidestep the declines in revenue seen at local European telco rivals France Telecom (NYSE: FTE  ) and Vodafone (NYSE: VOD  ) , where sales slipped 3% and 2%, respectively, last quarter.

Yet even as it held the line on revenues, Telefonica profits declined 12% last quarter. So I ask you, with Europe's problems still festering, is it really likely that Telefonica's going to turn things around, reverse last quarter's decline, and suddenly start growing at 12.5%?

Where's the cash?
Next point: You see how confused analysts are about the size of Telefonica's dividend yield? Yahoo! thinks it's 8.5%. Capital IQ thinks it's twice as big. Fact is, they're both wrong. Last month, Telefonica told investors that it was suspending its dividend payments and stock buybacks until "late next year" in order to save cash. So in the near-term, at least, it seems the most accurate number for Telefonica's dividend yield is not 15.6%, or even 8.5%. It's zero point zilch.

In fact, the dividend situation raises another point: Telefonica says it needs to conserve its cash -- which is all well and good. But isn't Telefonica actually rolling in dough -- $8.6 billion in annual free cash flow? One of these statements should be true, but it's hard to see how Telefonica can be making all this money on the one hand, yet still need to conserve the cash on the other -- at the same time. The two facts just don't jibe.

Foolish final thought
Seems to me that Telefonica's real problem is its debt load, which, at $76 billion net of cash, is bigger than that of any of the other publicly traded telcos. It's bigger than the $62 billion AT&T (NYSE: T  ) owes. Bigger than Verizon's (NYSE: VZ  ) $41 billion debt. Indeed, $76 billion is about 30% bigger than Telefonica's own market capitalization. This company is essentially one big I.O.U., with a telecom business stamped on the back.

So it seems to me that when Bernstein says it's time to sell Telefonica, it's making the right call. For the time being, so long as the European debt crisis roils along at least, investors looking to put money into telecom may be better advised to stick close to home and invest in companies they can keep a closer eye on -- Verizon and AT&T being the most obvious choices. (Indeed, I'm practicing what I preach. I've got Verizon pegged as an "outperform" in my own CAPS portfolio, and the stock's working out quite nicely). Or if it's safe dividends you're seeking, take a look at one of the nine rock-solid dividend stocks profiled in our recent report. (Our recent free report, I should mention).

Just don't buy Telefonica. It's not worth the aggravation.

Fool contributor Rich Smith holds no position in any company mentioned. You can find Rich on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 275 out of more than 180,000 members. The Fool has a disclosure policy

The Motley Fool owns shares of France Telecom. Motley Fool newsletter services have recommended buying shares of France Telecom and Vodafone Group.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (1) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 21, 2012, at 9:54 AM, Tsharp1947 wrote:

    You are a step behind on the dividend: it was cut ("suspended") completely at the last earnings meeting. I own the stock at a small loss and have Dec 15 covered calls. Unless there is a decent turnaround , I'll out in the next 3 to 4 months.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1990591, ~/Articles/ArticleHandler.aspx, 8/30/2014 10:13:17 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement