Portugal Telecom (PT) is a Portuguese telecom company that currently has a very attractive dividend yield of 11%. As the telecom sector is usually stable, this may be a good opportunity for income-investors to add both income and diversification to their portfolios. However, high-dividend yields are also a warning sign that deeper research is required before investing to see if the investment risk-reward ratio is compelling. PT has a market capitalization of $3.5 billion and PT's shares are listed on the New York Stock Exchange as American Depository Receipts [ADR]. One ADR represents one ordinary share, and holders of ADRs are entitled to the same rights as ordinary shareholders.
PT's core business is the telecommunications services, including mobile services. PT is an international operator focused in three main geographies: Portugal, Brazil and Africa. The focus in these geographies is due to historical reasons, since they are mainly former Portuguese colonies. In the Brazilian market, PT is present in Oi, the largest telecommunications operator in South America, with a equity stake of around 25%. It has also a stake in Contax, Brazil's leading contact center services company.
PT has more than 100 million customers worldwide, and in 2012, generated around 58% of its revenues outside Portugal, with Brazil responsible for 53.3% of its revenue. The weight of international operations in earnings before interest, taxes, depreciation and amortization [EBITDA] is lower, due to lower margins achieved in Brazil and Africa, compared to the domestic business. In 2012, operating revenues amounted to $8.6 billion, an increase of 7.4% from the previous year. The EBITDA stood at almost $3 billion, representing a 34.4% margin, which is quite good compared to its peers. However, due to a weak economic environment in Portugal, PT's EBITDA margin declined 1.2% over the last year, and further drops may happen over the next few quarters. In 2012, revenues from the Portuguese telecommunications business decreased by 6.6% compared to the previous year. In the first quarter of 2013, there was no sign of recovery with a 6.8% decline in revenues compared to the first quarter of 2012.
The weak performance of PT's domestic business is justified by the economic pressure it has felt over the past couple of years, due to Portugal's poor macroeconomic activity following its bailout from the IMF/European Union. Because of the austerity measures implemented since 2011, households and corporations have to cut spending, and telecommunications were not immune to those cuts. This has led to lower revenue and earnings in the company's domestic business during this period. On the other hand, Brazil and Africa have better economic outlooks and could boost PT's earnings for the coming years.
Historically, PT has a very good remuneration to shareholders, as usual within the European telecom sector. The company paid a relatively stable dividend from 2008 to 2011, which was slightly increased in 2010 to $0.85 per share. PT also paid $2.15 in special dividends during fiscal years 2010-11, following the sale of its shares in the Brazilian mobile operator Vivo to Telefonica (TEF) in 2010.
However, the company its dividend in half a year ago, and the last dividend paid was €0.325 ($0.43) per share. Its payment frequency is annual. Additionally, the company has a $265 million share buyback program ongoing until 2014. The dividend payout ratio was 120%, which is a very weak sign for the company's dividend sustainability. Moreover, the company's free cash flow was negative $330 million in 2012, leading to higher balance sheet leverage. PT's net debt was almost $10 billion at the end of the year, and increased by more than $500 million during the first three months of 2013. Its net-debt-to-EBITDA ratio was 3.3x at the end of 2012, among the highest in the European telecom sector.
Nevertheless, Portugal Telecom has one of the highest shareholder remuneration policies within the global telecom sector, given its dividend yield above 11%. This high-dividend may appear attractive, but another dividend cut may happen over the next few months.
PT relies on the domestic cash flow generation and the dividends paid by foreign subsidiaries to cover its own dividend commitment. The domestic cash flow generation is not enough to cover entirely the dividend payments, so PT relies heavily on dividends received from Oi to fund its own dividend. However, Oi is the most indebted Brazilian telecom company, and recently announced a dividend cut because it reached its maximum leverage target. Oi had net debt of $12 billion at the end of March, and recently reached a net-debt-to-EBITDA ratio of 3x, its self-imposed limit in its dividend policy. Therefore, it will not pay the next quarterly distribution, and if debt does not decline rapidly, it may not resume it over the next few quarters. As PT will not receive cash from Oi, its dividend is also seriously at risk.
Despite the fact that PT's yield is quite good, investors should remember that the company faces several issues that could make this high-yield investment a dividend trap down the road. The domestic business is facing strong headwinds, the company has a lot of debt, it is free cash flow negative, and more recently, it stopped receiving money from Brazil. Its dividend is therefore at risk, and if things don't improve considerably over the next few quarters, a dividend cut may be required. Nevertheless, even if the company decides to cut its dividend in half again, its yield would be above 5%, which is not bad, but probably not enough to compensate the risk assumed by investors.