I have bought and pitched Telefonica (TEF) to my Global Value Investor readers a few month ago. Let's take a look at the company now.
Telefonica is a Spanish telecommunications company operating in Europe and Latin America. In Europe, the main operating markets are Spain, the UK, Germany, Ireland, Italy, the Czech Republic, and Slovakia. Telefonica is also tapping into emerging market growth in Argentina, Brazil, Chile, Ecuador, Peru, Panama, Venezuela, Costa Rica, Dominican Republic, Colombia, Guatemala, and Puerto Rico, as well as in the U.S. and Canada. Certainly, the company aims at entering and developing its position in the Spanish and Portuguese speaking markets.
Telefonica is listed in Spain and on major foreign stock exchanges Euronext and NYSE. The ticker symbol on Euronext is TFA, and on the NYSE it's TEF. Telefonica stock is held by three institutional investors: Banco Bilbao at 6.28%, pension fund La Caixa at 5.05%, and Blackrock at 3.88%. With 85% free-float, it is a highly liquid stock.
Based on the prevailing market views of Spain, which are overwhelmingly negative at the moment, I have recently found Telefonica to be on the list of 52-week lows. This list is always a great source to find extraordinary investments. In fact, I feel reaffirmed that Telefonica is a great investment now that I can buy the stock even cheaper. Besides a free cash flow dictated dividend cut from 1.60 euro to 1.50 euro (-6.25%), nothing has fundamentally changed for the company. As the company has announced, it is partially substituting a cash dividend by a share repurchase:
The dividend for the year 2011 is maintained at 1.60 euros per share, having fulfilled already a first payment of 0.77 euros per share in November. The remaining amount (0.83 euros per share) will be distributed in May 2012, though the combination of a cash payment and a payment in-kind, the latter through the distribution of treasury shares of the Company for a maximum amount of 0.30 euros per share, and subject to market conditions.
Total shareholder remuneration for the year 2012 will amount to 1.50 euros per share, including the payment of a cash dividend of 1.30 euros per share and a share buyback for the remaining amount. Treasury shares acquired will be amortized and the share buyback shall be completed by May 2013.
Since Telefonica trades at 75% of book value, a share repurchase seems to be in the interest of shareholders. In addition, any investor who wishes to receive cash can simply sell their allocated shares and produce home-made dividends.
Looking at the valuation of the company, one could suspect that Telefonica is a distressed investment: a 52-week low, 25% discount from book value (which is remarkable for a defensive company), forward P/E of 6.5 and a leading dividend yield of 13.6%. Rather than being a security or company issue, it is likely, however, that Spain's debt issues are casting shadows over an otherwise very decent telecommunications company. The interesting point is that even if Spain entered into a recession, Telefonica would probably not be materially affected as its business model is not recession-sensitive. People will be spending more on using phones, mobiles and the Internet during a recession than, for example, restaurants and vacations.
Since the dividend has been cut to 1.50 euro going forward the application of the Gordon growth model as a dividend discount model yields a value of around 20 euro, or $26 per share in a more or less conservative case that assumes dividend growth of only 3% after 2013 and capital costs of 10%.
I consider the valuation simply too compelling to pass on Telefonica.
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Disclosure: I am long TEF.