Portugal's Bailout Is Over: Should You Buy Portugal Telecom SGPS (ADR)?

Telecom Portugal could perform better domestically thanks to the financial recovery in its home country. Is it a strong investment case though?

Jun 2, 2014 at 5:03PM

We recently found out that Portugal ended its three-year bailout program that saved the country from a deeper crisis. This makes Portugal the second country in the eurozone after Ireland to exit its bailout program without the safety net of a precautionary credit line. Now Portugal has largely freed itself from European Commission and International Monetary Fund oversight and has control of its policy and finances again.

The $107 billion bailout meant not only supervision, but also tough austerity measures. The country had to face painful labor reforms that increased the retirement age to 66 and lowered indemnity payments. Fiscal pressure was also key: Portugal progressively increased its sales tax to 23% and will raise it further to 23.25% next year, and it increased employees' social security contributions from 11% to 11.25% of wages. Portugal also increased its income tax this year and established an additional 3.5% levy on salaries that exceed $1,842 per month.

Thanks to these measures, the country managed to recompose its finances. It reduced its fiscal deficit to 4.9% of GDP -- a full percentage point below the target set by the government. In 2013, the country set a new fiscal record by collecting 57.8 billion euros -- a third of the country's GDP.

Should you invest in Portuguese ADRs?
With the exception of Portugal Telecom (NYSE:PTGCY) and some over-the-counter stocks, there aren't many Portugal-related assets that trade on the U.S. markets.

Portugal Telecom is an interesting case, as the company suffered a business contraction throughout 2013, along with the country. Its operating revenue dropped 5.4% year over year to $4 billion, and a drop in the Portuguese telecommunications business mainly explains this. Revenue from telecommunications business in Portugal was weak throughout the year, decreasing 5.2%. The company could not increase prices in this competitive market, and the macroeconomic environment did not help.

The first quarter did not bring great figures, either: The company's operating revenue dropped 3.9% year over year to $941.6 million. The residential segment of its Portuguese operations remained the main source of the drop. A key variable, average revenue per user (ARPU), decreased 9.2% year over year in the personal segment and 8.2% in the enterprise segment. The average consumer in the country is still trying to cut their bills, while corporations, especially in banking, are implementing cost-cutting initiatives that make it hard for Portugal Telecom to increase its sales.

Looking forward
Portugal Telecom's international assets generate 56.5% and 52.1% of the company's consolidated revenue and EBITDA, respectively. So the situation in Portugal cannot be ignored, but international operations (particularly in Brazil) could drive faster growth. Why? Portugal will likely continue to face austerity measures for quite some time, and this will continue to impact operations in the country. Emerging markets, although they slowed down in the first quarter, still present opportunities for faster growth than Portugal offers in the short term. Brazil in particular could offer opportunities after its presidential elections in October; before then, we're unlikely to see investment announcements in telecommunications infrastructure.

In the beginning of May, Moody's upgraded Portugal's sovereign debt from "Ba3" (junk) to "Ba2" (still junk, but better). The yield for 10-year Portuguese bonds has dropped from 6% at the beginning of the year to 3.8% now, which indicates greater confidence in the country's debt and lower financing costs for the country.

The country's improved perception might help Portugal Telecom get fresh cash at better rates, which it could inject into its international operations to boost growth. The company's average cost of net debt stood at 5.4% in the quarter, which is reasonable, given Portugal Telecom's financial position. It's hard to think of major credit improvements that could occur in the short term.

Final thoughts
The tough reforms that Portugal had to face in the past two years came to fruition. The country is in better shape financially than it was before. However, all these austerity measures have left domestic demand quite depressed, and GDP dropped 0.7% in the first quarter.

Two things must be taken into consideration. First, supervision is not entirely over, as the EC and the IMF will review the health of Portugal's economy twice a year until 2035, when 75% of the loan will have been paid back. Second, the country is not yet done with its austerity measures; the government has in fact confirmed their continuity.

The overall impression is that the worst for the Portuguese economy has already passed, but there are major doubts regarding the effectiveness and economic sustainability of the measures that have been applied so far. Unemployment remains over 15% -- slightly below the 17.5% mark reached a year ago, the highest level recorded in decades.

Therefore Portugal Telecom will still face a slow recovery in its depressed domestic market. The government has forecast GDP growth of 1.2% this year and 1.5% next year. However, this will not necessarily mean higher salaries or disposable income that could translate into higher profit for the company. Its international operations, on the other hand, are stable and could present better opportunities looking ahead.

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