Is Portugal Telecom Destined for Greatness?

Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let's take a look at what Portugal Telecom's (NYSE: PT  ) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Portugal Telecom's story, and we'll be grading the quality of that story in several ways.

Growth is important on both top and bottom lines, and an improving profit margin is a great sign that a company's become more efficient over time. Since profits may not always be reported at a steady rate, we'll also look at how much Portugal Telecom's free cash flow has grown in comparison to its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Portugal Telecom's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Portugal Telecom managing its resources well? A company's return on equity should be improving, and its debt-to-equity ratio declining, if it's to earn our approval.

Healthy dividends are always welcome, so we'll also make sure that Portugal Telecom's dividend payouts are increasing but at a level that can be sustained by its free cash flow.

By the numbers
Now, let's take a look at Portugal Telecom's key statistics:

PT Total Return Price Chart

Source: PT Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

(18.1%)

Fail

Improving profit margin

(41.6%)

Fail

Free cash flow growth > Net income growth

(87.8%) vs. (63.8%)

Fail

Improving EPS

(70.1%)

Fail

Stock growth (+ 15%) < EPS growth

(20.9%) vs. (70.1%)

Fail

Source: YCharts. * Period begins at end of Q3 2009.

PT Return on Equity Chart

Source: PT Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(94.4%)

Fail

Declining debt to equity

(54.9%)

Pass

Dividend growth > 25%

(19.9%)

Fail

Free cash flow payout ratio < 50%

452.8%

Fail

Source: YCharts and Morningstar . * Period begins at end of Q3 2009.

How we got here and where we're going
This is one of the worst scores any stock can get, and Portugal Telecom is saved from earning a complete goose egg only because of its lower debt levels relative to its equity. Nothing else is moving in the right direction. The company even failed to earn a passing grade by sustaining higher levels of free cash flow than net income -- something that should be easy for a telecom.

Contrarians might point to Portugal Telecom's position in Brazil and China, but thus far, that hasn't been enough to offset the slow but unstoppable decline in Portugal itself. In the company's third-quarter earnings call , it was revealed that Portugal-sourced revenue had fallen 6.7% year over year, notwithstanding a 4.1% increase in residential revenue.

Portugal Telecom would seem to be the ideal company to move into Brazil, what with the shared culture and language, but according to a Brazilian telecom analysis, the current market share breakdown looks like this:

Telecom 

Partner / Owner?

Market Share in Q4 2012

Vivo 

Telefonica (NYSE: TEF  )

29.1%

TIM 

Telecom Italia (NYSE: TI  )

26.9%

Claro 

America Movil (NYSE: AMX  )

24.9%

Oi (NYSE: OIBR  )

Portugal Telecom (22.4% owner) 

18.8%

Sources: Teleco Brazil and corporate sites.

Portugal Telecom owns a fifth of the fourth-place telecom. More importantly, it has a weaker position from which to compete. Here's a breakdown of these four competitors on a cash flow and capital expenditure basis:

Telecom

Capital Expenditures

Free Cash Flow

Telefonica 

$13.0 billion

$9.1 billion

Telecom Italia

$8.5 billion

$2.7 billion

America Movil

$11.2 billion

$6.0 billion

Portugal Telecom

$2.0 billion

$190 million

Source: Morningstar. Numbers are for trailing 12 months.

The only telecom that's even close to Portugal Telecom's spending is Telecom Italia, and it generates over 14 times as much in free cash flow. Diversification is good if a company can diversify defensibly, but with this sort of competition, Portugal Telecom is going to have its work cut out for it in Brazil.

Putting the pieces together
Today, Portugal Telecom has very few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

 

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Read/Post Comments (2) | Recommend This Article (3)

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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 February 12, 2013, at 11:08 AM, pioneerg wrote:

    Ryan Peckyno said this was an outstanding company to invest in back on January 16. Now you say its one to stay away from. Funny how two different people have such widely differing opinions.

  • Report this Comment On March 05, 2013, at 3:04 AM, bubbajrthesecond wrote:

    Done made my money on it. Didn't seem like it was anything worth long term. It peeked my attention has a hit and run try when I started seeing all the articles about all the dividends it pays. Made a nice little two month return on it.

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