Telefonica (NYSE:TEF) will be announcing Q4 2015 results before the market opens in Europe on Friday 26th and this could be a good opportunity to accumulate on any weakness. The company offers a tremendous dividend yield of 7.28% on a semi-annual pay-out. The share price is towards the bottom end of its 52 week range after the general market decline and would seem to have far greater upside potential than downside risk.
Its PEG (price to earnings/growth) of 0.45 is attractive given that a PEG ratio of under 1 is generally considered to show that a company's share price is under-valued. Macro factors favor the company in Europe as Spain and Southern Europe recovers, with Spain having enjoyed 3.2% growth in GDP last year. The continuing melt-down in the Brazilian economy is a negative factor for the company in the short run. However, the company has been increasing market share in this difficult market.
Telefonica has been putting some important new strategies in play since I wrote about the company in November last year. With its approximately Euros 50 billion in debt, the company has been looking at ways to reduce its indebtedness position. It has a target to reduce debt to about Euros 31 billion. Much of this is likely to come from the sale of its UK subsidiary, O2, to Hutchison Whampoa (OTCPK:HUWHY) for a reported £10.25 billion. A decision on regulatory approval for this deal by the European Union Competition Commission is expected by the middle of this year. This has led to some unwelcome uncertainty for Telefonica and thus its share price. Hutchison executives are due to have a hearing with the EU on March 4th.
Germany is highly profitable for Telefonica and Eastern Europe is likely to see more developments for the company in the near future as joint ventures come into play. Throughout Europe the company is investing in Pay TV. This is a particular opportunity in Spain where the penetration rate of Pay TV services is low. Pay TV in Europe has greater growth potential than the slow to moderate growth picture for telecoms as a whole.
In January it announced plans to spin off its Spanish towers unit (along with some subsea cabling,data centers and fiber optic network) by July this year. This is expected to raise about Euros 6 billion for its Spanish facilities, and possibly a further Euros 4 billion for towers owned elsewhere in Germany and Brazil if they were to be included. The new entity is to be called Telxius.
In another cost-cutting move, Telefonica has launched a staff early retirement plan. It will involve long-serving staff having the option to stay at home on 68% of their salary. The company has about 28,000 employees in Spain itself. This will lead to an initial Euros 2.9 billion charge but produce long-term savings. This can be seen as part of the long-term strategy to move the company away from its previous incarnation as a top-heavy State subsidy outfit.
Telefonica is by far the biggest player in Spain's mobile market and also controls the country's fiber-optic broadband market. A former state-run business it has in recent years lost out somewhat to its more "mean and lean" competitors, Orange and Vodafone. The re-organizations it is undergoing will, it is hoped, indicate a more "mean and lean" look itself to Telefonica.
Cost-cutting has been necessary in the face of stronger competition. One way it is tackling competition head-on is by signing up, at a cost of Euros 2.4 billion, to show Spanish soccer broadcasts, and other European matches, under its "Movistar" brand. The company controls about 85% of the country's pay TV market and is looking to move to higher margin services.
Telefonica is the world's biggest telecoms operator for the Spanish and Brazilian speaking world. The division's Brazil and Hispanoamerica (effectively Latin America less Brazil) divisions have been hit by that continent's problems. There are some bright spots there, in particular in Mexico where its Movistar mobile operation is doing well. Even in Brazil, the company has managed to accelerate OIBDA (Operating Income Before Depreciation and Amortization) growth through their mobile player Vivo and fixed line operator Telesp.
In Q3 2015 the company surprisingly managed to increase sales in Brazil by 5.2% and in Hispanoamerica by 12.6%, indicating they are increasing market share in Latin America. This is a very positive indicator for when the recovery in Latin American countries finally happens. Telefonica's exposure to Latin America sets it apart from its European competitors. However, the fact that Brazil is 26% of the company's OIBDA will be seen as a negative by some. The dire economic situation in Venezuela can also be seen as a negative for the company.
Analysts are mixed on the company's prospects. Recent calls from both Barclays and Independent Research rated the stock as Neutral, while Macquarie moved it up to an "Outperform". There is somewhat of a wait and see attitude as investors see how the regulatory approvals and restructuring pan out.
The many possible consolidation moves within the telecoms sector worldwide should prove to be a positive.
The 7.28% dividend yield is an attraction though and I would think this will be maintained as long as the sale of O2 goes through. The company did cancel dividend payments in July 2012 but reinstated them in 2013. All the indications are that they will maintain the high dividend pay-out now. Investors should watch for any comments about dividends when the company reports this week.
Risks for company performance include regulators not approving asset sales which will harm their efforts to raise cash and thus result in continued high leverage. Given this relatively high leverage, a drop in bond markets could have a negative effect on the share price. The company has targeted to reduce its net debt position from 2.9 to something below 2.35 x net debt EBITDA (Earnings Before Interest Tax Depreciation and Amortization).
Telefonica should benefit from the incipient recovery in Europe and provides an opportunity for investors who might want to take a long-term position in Latin America. A more private sector corporate outlook should help increase profitability and the company looks a good long-term Buy for the patient investor.
Disclosure: I am/we are long TEF.
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.