Shares of the leading telecommunication company in France, France Telecom (FTE), have lost over 30% of their value since the start of the year and the recent announcement by the company to slash its dividends further have not helped their cause. Company's cash flows continue to decline on a consistent basis which is a worrying sign.
Increased competitive pressures in its domestic market, slowdown of growth in Spain and the ugly economic picture in Europe are all key factors at play behind the company's lack of revenue growth. Moreover, the management has provided a very weak economic outlook for the year 2013, which leads me to believe that a turnaround in the company's operations and its stock price is very unlikely in the near future. The stock remains attractive from a dividend perspective even after the dividend cut, currently yielding almost 10%. However, it is very likely that the management might further cut dividends to preserve its financial flexibility. As such, I give a 'neutral' rating on the stock.
The chart above indicates the poor performance of the company's stock. Furthermore, it also points out that on a total return basis, a high dividend yield is largely offset by the significant drop in price.
Domestic competition taking its toll
FTE derives the majority of its revenues from its domestic operations. In recent quarters, the company has been experiencing a drop in revenues. On one hand, there is the economic slump in the region that is causing consumers to spend cautiously. On the other hand, fierce competitive pressures are leading to a loss in its market share in the mobile market.
France telecom has entered into a price war after the recent introduction of Iliad and its "Free service". To cope with the lower charges on offer by Iliad, FTE has followed suit to retain customers, but at the expense of falling revenues and profits. Iliad's free service has shaken up the French market, with the company announcing that it attracted 3.6 mm mobile phone subscribers since its January launch. These 3.6 mm connections represent a 5.4% share of the market in a very short time span. Going forward, I expect this competition to continue to reflect adversely in FTE's financials.
Revenues in Spain were down 1% in the third quarter, with deterioration seen across the majority of its key business metrics. Even though the company mentioned the macro economic environment as one of the reasons behind the slowdown, intense competition and continued pricing pressure remain the key drivers for the Spanish mobile market. Despite a slight increase in net postpaid additions during the quarter, the company lost ground in the prepaid segment of the market. The table below illustrates the consistent quarter over quarter decline in the revenues the company derives per subscriber.
Positive takeaways from Q3 results
Iliad's entry as a low cost mobile operator has undoubtedly impacted France Telecom among others in the region. However, since Iliad's entry into the wireless market in January of 2012, the company's mobile customer base is starting to grow again. In the first quarter, France telecom lost approximately 400,000 contract customers on a sequential basis, while adding 86,000 customers in the second quarter. In the quarter ended recently, its customer additions finally returned to growth with total additions of 320,000 contract subscribers.
The chart indicates how Iliad's entry in Q1 impacted FTE, but ever since, the company has brought back growth in its customer base.
Weak outlook for 2013
Following is an extract from the company's latest earnings release.
As in 2012, the Group will face a more difficult environment in 2013 than initially expected. The macro-economic outlook, particularly in Europe, will remain marked by very low growth in France. Despite the resilience of its mobile activities, the Group will continue to suffer the effects of unprecedented competitive pressure, which weighs on the overall value of the market.
Constantly changing policy on dividends
FTE has changed again its dividend policy, having already changed it last February. In February, the payout was estimated to be around 1.20 euros ($1.56) per share, after the cut from the previous 1.40 euros ($1.82). Following the earnings announcement, the company is now expected to pay 0.80 euros ($1.04) per share in dividends, with an aim of reducing its leverage to 2x. Despite the dividend cut, the yield is attractive at 9.6%. However, I do not expect this yield to be sustainable as the company needs to reduce its leverage and may further cut its dividends like other telecoms have in the region. With the recent tie up of its dividend policy to operating cash flows, the company would have to stabilize its operating cash flows first and then bring growth in them to convince the investors that its dividends are sustainable. In the absence of such growth, its dividends will be susceptible to a further cut.
FTE is trading at 6 times its forward earnings, which makes the stock undervalued when compared to the said multiple of some of its peers. Vodafone Group Plc. (VOD) is trading at 10 times its earnings, whereas the Spanish telecom carrier, Telefonica (TEF) is trading at 7x. However, in my opinion, the attractive valuations will not matter much unless earnings and operating cash flows stabilize, which is unlikely in the short term. Despite the company's leading position in the telecom industry, I suggest investors wait to take advantage of both, capital appreciation and dividend rather than dividend alone.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.