This article is part of our Rising Stars Portfolios series.
You think 10% unemployment is bad? Try 20% -- that's the unemployment number right now in Spain, one of the many Eurozone countries getting dragged down by anemic growth, massive debt, and a rigid labor market. And now that Ireland has officially accepted an EU/IMF bailout for roughly $90 billion in external support, many speculators think Spain might be the next domino to fall.
A possible silver lining?
There's no denying that Spain faces serious obstacles over the next few years. As investor concerns continue to mount over Spain's ability to service debt, President Jose Luis Rodriguez Zapatero is running out of the necessary political capital to push through pension reforms and other austerity measures. Rival conservatives are calling for national elections, while Zapatero's Socialist backers are angry about his leadership and proposed reforms. Spanish jobless claims rose in November, pushing the unemployment rate up to 20.7%, twice the average rate of the other Eurozone countries. Furthermore, Spain faces a demographic crisis that reflects an aging population and an eroding tax base.
Sounds great, right? What a sales pitch! Now, are you ready to invest in some insanely underpriced Spanish stocks?!
Remember what Buffett said about being greedy when others are fearful? Right now, no one wants to touch these stocks with a 10-foot pole. And that tells me that now's the right time to buy Spanish telecom provider Telefonica
Telefonica fast facts
|Market Capitalization||$102.33 billion|
|Revenue (LTM)||$80.55 billion|
|Earnings (LTM)||$15.32 billion|
Source: Capital IQ, a division of Standard & Poor's.
Telefonica may be a company tied to the Spanish economy, but don't let that fool you; it's extremely geographically diversified, and most of its growth in the years to come will occur in Latin America and Eastern Europe. 42% of the company's 2010 revenue so far has come from Latin America, while another 25% has come from European countries besides Spain.
Despite the difficult economic environment at home and throughout the rest of Europe, Telefonica was able to increase revenue by 6% during the first nine months of the year. And it didn't do so through cost-cutting or slashing overhead -- the company experienced 7.1% organic access growth, bringing its total number of accessees to 281.8 million. Even more impressive, at a time when global demand has softened and people are looking for ways to cut down on bills, Telefonica kept its churn rate completely stable at 2.3%.
Here's a brief look at how the company's three main segments have fared thus far in 2010:
- Spain: Revenue fell 4.2% amid stiffer competition and lower usage in all business areas. However, mobile customers increased by 7.3%, and the company managed to slightly decrease operating experiences by 1.2%. Although wireline losses are inevitably mounting, the company has been able to increase its market share in both pay TV and mobile broadband.
- Latin America: Revenue increased by 6.9%, as reflected by double-digit mobile service growth and pay TV revenues. Access grew by 9.4% overall, helped by strong expansion in places like Argentina, Brazil (including the acquisition of Vivo), Colombia, Chile, and Peru. Even though there's been great growth in Telefonica's customer base, average revenue per user (ARPU) has remained stable, which is a terrific sign.
- Europe: Revenue grew by 6.4%, of which 3.7 percentage points came from organic growth. Mobile broadband enjoyed the greatest expansion, with 46% growth over the first nine months of the year. Overall access grew pretty dramatically, although this resulted in ARPU declines in almost all major regions (U.K., Germany, Ireland).
To see more arguments in Telefonica's favor, read my prior article urging readers to buy the stock.
So what's it worth?
When I first recommended the stock in early August, it was trading around $70, and I had it valued between $82 and $86, which represented a nice 20% margin of safety. Since that time, it rose all the way to $80.85, but has since dropped even lower, to about $68 yesterday.
I think that the price might continue to suffer in the near term, as the markets grapple with how to handle the crisis in the Eurozone. A lot will depend on the political resolve of sovereign nations to institute necessary reforms. Although I think Telefonica will continue to see solid growth in the next few years, bolstered mostly by Latin America, I decided to run a "worst-case" scenario in which growth was flat and margins got squeezed. Even in that worst-case scenario, I still believe the stock is worth about $74.28. In my midrange scenario, the stock is still worth about $80, which is substantial enough for me to move forward and recommend a purchase.
Futhermore, investors have been clamoring for high-yielding stocks lately, excited at the prospect of getting some income while Treasuries provide next to nothing. Two domestic telecom companies in particular, Windstream
There's nothing necessarily wrong with either of those companies, but neither is expected to grow at all over the next five years, and both have very high payout ratios. It's true that with Telefonica, you have to deal with a Spanish dividend tax. Still, combine the dividend with the great upside, and I think you have yourself a long-term winner.