Investing in Foreign Telecom Until Market Shows Clear Direction

The recent rally in the markets has been criticized by most as a typical bear market rally, while even the longer term bulls feel that a pullback is necessary for the health of the markets.

Valuations have begun to become overly bullish considering the collapse in fiscal year 2009 earnings estimates for the S&P 500 components, and technical indicators are all signaling that momentum is fading and we are due for a sell off.

I feel like a move to the low 800s could be the best longer term move for the markets, forming an inverse head and shoulders on the S&P 500, a classic reversal pattern for what could be a sustainable bull market.

However, one group of stocks that remains cheap is the foreign telecom services, with yield dividends that outpace the returns of most Treasuries and other investments considered "safe". Risk appetite in the markets is improving, as seen by credit spreads and money flowing into riskier assets, and I feel the enormous amounts of cash on the sidelines will be put to work once the S&P approaches the 800 level.

Until that time, here are a few of the foreign telecom service stocks that appear to be spectacular intermediate-term investments based on valuation, fundamental business outlook, and a small amount of technical analysis:

Brasil Telecom (BRP) Shares of one of the fastest growing telecom stocks trade just 5.8X forward earnings, 1.9X cash, and at a PEG of 0.22, while having a 8%+ dividend yield (although it was a surprise dividend). Shares are 30% off a double bottom, but would need to climb another 100% to reach levels seen just less than a year ago. Regulatory issues have held up an offer made by Brazil's Oi Participacoes for BRP, with a price tag of $3.5B that could rise to $7.5B when taking into account minority shareholders. BRP currently has a market cap just over $2.8B, so the value in shares at this level is clear.

Telefonica (TEF): The Spanish Telecom giant trades just 7.6X forward earnings, 8X free cash flow, and a PEG of 0.89, while yielding a 6.83% dividend. Recent earnings reported that Latin America growth is boosting the company's bottom line. Shares are only 15% off a double bottom low, and still around 55% below levels of this time last year. Despite a slowdown in Spain's economy, opportunities elsewhere leave Telefonic as a global telecom leader.

Millicom International Cellular (MICC): Millicom trades 9X forward earnings, 4.9X free cash flow, and a PEG of 0.95, while yielding a 4.5% dividend. Shares recently broke above its 200 day exponential moving average, and are in a strong trend higher, although it is trading at less than half of its $120 price last year at this time. Millicom is a big player in emerging markets in Central America, Africa, and Asia and is likely to grow faster than most of its competitors. The company is considering selling its Asian operation which could catch a high price tag, and is actively seeking joint ventures to limit further risks of being shut out of certain countries due to regulatory issues.

Indonesia Telecom (TLK): This rapid growing telecom provider trades 12X forward earnings and at a PEG of 1.97, slightly higher than many industry counterparts, but also pays a 10.17% dividend and has the top margins and profitability ratios (ROE, ROA, ROI) in the industry. Indonesia is an emerging market that is often forgotten, and expansion in the economy will continue to benefit the main telecom provider. A recently launched Indonesia ETF (IDX), has gaine nearly 50% this year, and could be a great addition to diversify any portfolio. IIT is another Indonesian Telecom stock, although valuation and technicals point to TLK as the better play.

Another way to play this is through the Emerging Markets Telecommunications Fund (ETF), as the necessity for telecom in both rural and urban areas in both developed and developing markets remains to grow at a much faster rate than the global economy as a whole. Risks to the sector include a reduction in cash flows to meet debt obligations, from high CAPEX spending, due to overall business spending declines.

Many Telecom firms are littered with high amounts of debt, but the unfreezing of the credit markets coupled with record low interest rates should benefit the individual companies going forward. The growth in the industry will continue without questions, as only 25% of India's population has regular telecom service, and internet usage in Brazil is expected to grow more than 10% per year for the next five years.

Another added benefit is that these foreign telecom companies pay dividends in local currency, which gives the added benefit of a declining US dollar in a market correction.

Disclosure: No Current Holdings; Considering buying TLK, BRP, and MICC this week. Took 55% gains in TEF calls last week.

Comments

[YoYoMama]

To the author - any comments on TNE, TKC, MTA and CEL?

2009 May 18 02:00 PM