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Having grown weary of a flat decade in the stock market, investors have jumped back on the dividend bandwagon, clamoring for high yields in safe places. Telecom companies fit this mold nicely, as early investments in infrastructure tend to leave a company with tons of free cash flow, which ultimately ends up in the pockets of shareholders. Over the past year, domestic telecoms like Windstream
And there's one company in particular that's positioned nicely to profit from all the EU uncertainty, and that's my "11 O'Clock Stock" pick: Telefonica
Telefonica fast facts
|
Market Capitalization |
$106.6 billion |
|
Revenue (TTM) |
$73.10 billion |
|
Earnings (TTM) |
$9.90 billion |
|
Dividend Yield |
5.7% |
|
Key Competitors |
Vodafone |
Sources: Capital IQ, a division of Standard & Poor's, and Yahoo! Finance. TTM is trailing 12 months.
Fierce competition
Telefonica is a diversified telecommunications provider that has operations in Spain, Western and Eastern Europe, and Latin America. In Europe, the company operates in an extremely competitive environment, where fixed-line telephony is on the decline and wireless penetration rates have reached peak levels. Several large companies, such as Vodafone, Telecom Italia
|
Telefonica |
Vodafone |
France Telecom |
America Movil |
|
|---|---|---|---|---|
|
Market Cap |
$106.6 billion |
$126.02 billion |
$56.9 billion |
$103.0 billion |
|
Forward P/E |
9.0 |
9.8 |
10.2 |
12.9 |
|
Dividend Yield |
5.7% |
5.5% |
7.7% |
0.5% |
|
EBITDA Margin (%) |
37.70% |
33.20% |
35.70% |
39.50% |
Source: Capital IQ, a division of Standard & Poor's.
EBITDA = earnings before interest, taxes, depreciation, and amortization.
Because Telefonica has such a strong presence in its home country of Spain and throughout Europe, it has one of the highest EBITDA margins around. It pays a solid dividend of 5.7% (which it increased six consecutive years) and is trading forward well below its five-year historical P/E of 14.22. Furthermore, out of all the European incumbents, Telefonica seems to have the most growth potential because of its presence and aggressive acquisition strategy in Latin America.
Not the bay of PIIGS!
It's been more than six months since the EU debacle started rippling through the credit markets, and still investors aren't exactly jumping over their chairs to scoop up shares from countries like Greece, Spain, or Italy. And that's one reason why Telefonica is down about 15% so far this year: As a Spanish company, it's been lumped in with the other debt-straddled countries just barely gasping for air.
But Spain is only one small part of Telefonica, and that's what investors don't understand. The Spanish market accounts for 35% of revenues, while Europe accounts for 25% and Latin America comprises about 40%. Telefonica is the incumbent provider in more than five countries and holds the No. 2 or 3 positions in 10 separate countries. Check out the revenue growth in all three geographical segments since last year:
Source: Company presentations.
As you can see, the downward trend in Spain has already started to reverse course, and revenues in both Europe and Latin America have been on a steady rise so far in 2010. Since the beginning of the year, the company has been able to add 13.4 million subscribers, which is 2.4 times more than in the first half of 2009. Net adds in the second quarter were 4.7 million, which reflects not only an increased commercial effort, but also a decrease in the churn rate, which has dropped to 2.2%.
Another concern of telecom investors is that fixed telephony is declining, mobile penetration rates are high, and average revenue per user (ARPU) has been declining. This is definitely a legitimate threat, especially if companies can't continue to expand market share and add subscribers. Fortunately for Telefonica, the decrease it has seen in fixed telephone lines has been more than offset by growth in mobile, data, broadband, and pay-TV.
By the end of June 2010, Telefonica had seen year-over-year increases of 9.7% to its mobile accesses and 84.6% in mobile broadband accesses. Especially striking was the first half net adds in Latin America, which increased by 71.5%, due primarily to improving trends in places like Brazil, Colombia, Peru, Argentina, and Chile.
In addition, Telefonica recently achieved a pretty significant milestone as it managed to successfully reach an agreement with Portugal Telecom to buy its 50% stake in Brasilcel, the joint venture that holds a 60% stake in Brazil's mobile phone company, Vivo. The acquisition will make Telefonica the undisputed leader of the Brazilian mobile market, which has 150 million cellular users (fifth-most in the world).
The buy opportunity
As I mentioned earlier, Telefonica's stock, in my opinion, has been pummeled unjustifiably this year. Fears of a deep recession in Spain and decreasing opportunities for market expansion have caused investors to overlook several key points that make Telefonica a great purchase.
First, it's one of the most geographically diversified of all the European telecoms, and its recent agreement to purchase Brasilcel only strengthens its opportunities in Latin America. It consistently has the highest EBITDA margins in its European peer group, and its ability to generate gobs of free cash flow enables it to pay a solid dividend, one that it has committed to growing by at least 25% by 2012.
From a valuation standpoint, Telefonica also seems to be very attractive. Using a discounted cash flow model, I assumed very moderate growth, slowly declining margins, and a 12% discount rate; my estimated fair value is in the range of $82-$86. Currently priced at $70, this represents a solid 20% margin of safety. Coupled with a dependable yield, seasoned management, and an ability to increase both the top and bottom line, Telefonica may be the best foreign telecom play there is.
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