Can France Telecom Maintain Its Generous Dividend?

| About: Orange (ORAN)

In today's low interest rate environment, investors everywhere are searching for yield. Bond yields are low, and all sorts of formerly high yielding companies have seen their prices increase, decreasing their dividend yields at the same time. Investors have been forced to increase risk just to get yields that were commonplace just a few short years ago.

Thanks to the overall weakness in Europe, shares in France Telecom (FTE) have fallen to levels not seen since 2002. The company is also facing headwinds from a new competitor, Illad, who quickly captured 5% of France's wireless market in 2012. France Telecom's latest quarterly numbers did indicate a small growth in wireless subscribers in the last quarter, but the new competitor should still be a worry to investors.

Because of this general weakness, the company announced it would cut their 2012 dividend - of $1.75 per share - to a minimum of $1.04 per share over the next two fiscal years. This cut is due primarily to a forecasted drop in cash flow, as well as the company dedicating more capital to debt repayment.

If the dividend is in fact $1.04 per share, (American investors will most likely see some of that withheld at source) that represents a 9.9% dividend yield. Typically, any dividend that high is usually perceived by the market as incredibly risky. Is that the case with FTE?

According to Yahoo Finance, analysts are forecasting the company to earn $1.67 per share for 2013, which is enough to easily cover the dividend. 2014 could be even better, as the company plans to work through aggressively priced contracts it signed with French customers in 2011-12.

The company is also rolling out 4G coverage to 15 of France's largest cities by the end of the year, which should help them retain high margin data accounts. They've also rolled out 4G coverage to the UK market, and expect to have 98% penetration by 2014. Today's youth (myself included) are tethered to our smartphones, 4G coverage will further strengthen customer loyalty.

France Telecom also has exposure in several high growth developing markets, including Poland, Egypt, Morocco, Kenya, and recently, Qatar. In fact, the company has diversified operations so less than half of their revenues come from France. The problem is the number two and number three markets are Spain and the UK, respectively, two markets that are expected to be weak in the near future.

Overall, operationally, I think France Telecom will see a bit of weakness over the short term, but should start to show improvements sometime in the 2014-15 timeframe, pretty much exactly the same as the company's timeline. This will obviously depend on the overall economic health of France and Europe overall, but this should improve over time.

FTE has stated their goal is to reduce their overall debt to 2x their EBITDA by the end of 2014. They're currently sitting on $10.4B of cash, and $4.7B of debt mature in 2013. They'll also have the expense of the dividend, which will cost them approximately $2.7B. If they can meet their forecasts of $9.3B in EBITDA for the year, the company will have no problem both paying down debt and paying the dividend. (All figures converted from Euros to US dollars.)

Overall, France Telecom's dividend is fairly safe. As others have stated, the company also looks attractive on a valuation basis, especially from a P/E and a P/B perspective. If you combine the attractive dividend and the potential for capital gains, it looks like a decent entry point for the stock. You can enjoy the dividend as you wait for the European economic picture to improve and send this stock higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.