While I have written bullish articles about domestic telecom in the past, I believe that the greatest risk/reward exists abroad. Vodafone (VOD) and Mobile TeleSystems (MBT) are two companies with international exposure that have strong dividend yields and limited downside. The Street currently rates both companies a "strong buy," but gives slight preference to Vodafone due to its stellar fundamentals in India.
From a multiples perspective, MTS is the cheaper of the two. It trades at a respective 11.5x and 8.4x past and forward earnings while offering a dividend yield of 7.4%. Vodafone, on the other hand, trades at a respective 12.6x and 9.4x past and forward earnings -- skewed towards the high-end of peers -- while offering a dividend yield of 5.5%. With that said, the company has a much lower beta (0.82 versus 1.47) and a larger emerging market footprint. Gross margins stand at a dismal 32.8% for the firm, but management has said that it is focusing on cutting costs.
At the first quarter earnings call, Vodafone's CEO, Vittorio Colao, noted geographical strength:
[W]e… see improving performance in our other core European markets, Italy, Germany and continued momentum in Vodacom and in India.
In our strategic growth areas, we continue to perform well with data, up 25%, driven by smartphone penetration; fixed, up 6%; and AMAP, which mainly covers our emerging markets, up by 8.7%. We also saw continued good growth in messaging, plus 5%.
Emerging market growth has been so stellar that, in early November, the firm guided for higher annual profit than what it previously estimated at 11.4B - 11.8B pounds. Service revenue in India accelerated 20.1% in the second quarter due to greater calling hours and web browsing activity. Data volume growth in Europe has also occurred with flat capital expenditures and macro headwinds.
Competition in Italy, however, is limiting upward potential in the top-line. Second quarter organic service revenue accelerated to a decline of 3% in the country. With that said, double-digit nominal GDP growth in India will more than offset the loss, especially considering Vodafone's opportunities in data and enterprise. Management has also recently indicated a commitment to cutting costs, which should result in an ultimately more aggressive capital allocation policy.
Consensus estimates for Vodafone's EPS are that it will grow by 2.7% to $2.68 in 2012, grow by 7.1% in 2013, and then decline by 1.7% in 2014. Assuming a multiple of 13x and a conservative 2012 EPS of $2.84, the rough intrinsic value of the stock is $36.92, implying 36.8% upside. Even if the multiple were to contract to 11.5x and 2012 EPS turns out to be 5.6% below the consensus, the company would still appreciate. Considering the top emerging market exposure and limited downside, I fully recommend Vodafone as an attractive defensive play.
While the main attraction to Vodafone is Indian growth, the main attraction to Mobile TeleSystems is its clean balance sheet and strategic activity. The company has low external debt risk and has attractive cash utilization due to conservative leverage. Mobile TeleSystems is the leader in the Russian mobile market and has 50M subscribers in Eastern Europe. In addition, the firm also proved operationally successful in the third quarter when EBITDA grew 10.5% sequentially and sales in Ukraine grew 12% sequentially. EBITDA margins also expanded as a results of efficiency efforts. And the integration of MGTS, coupled with 3G rollout in Russia, will only further drive revenue acceleration. As Russian smartphone and Internet use increases, MTS is in a solid position to create value.
Consensus estimates for MTS' EPS are that it will decline by 4.5% to $1.48 in 2011 and then turnaround to grow by 15.5% and 16.4% in the following two years. Assuming a multiple of 11.9x and a conservative 2012 EPS of $1.66, the rough intrinsic value of the stock is $19.75, implying 39.1% upside. Even if the multiple were to decline by 10x and 2012 EPS turns out to be 5.8% below the consensus, the stock would still appreciate.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VOD over the next 72 hours.