Misleading Payout Ratios In Emerging Market Telecoms

Includes: PHI, T, TEF, TEO, TLK, VIV, VOD
by: Analytical Chemist

The telecommunications industry is a popular source for companies with high dividend yields. Investors often use a payout ratio as a metric to ensure that companies are able to support the dividend. In previous articles on domestic, small-cap, and international telecoms I've written that using a payout ratio based of net earnings isn't a good metric for telecommunications companies. My preferred metric is to calculate the dividend as a ratio of owner earnings. Owner earnings are a measure of how much cash the company generates while maintaining its business position. The calculation is relatively straightforward: start with net earnings, add back non-cash charges such as depreciation and amortization, and subtract the capital expenditures necessary to maintain the business.

Large domestic telecoms like AT&T (NYSE:T) and Verizon (NYSE:VZ) are the two of the most commonly stocks held by Americans seeking yield. Investors seeking additional yield may look to some of the smaller domestic telecom companies. Sometimes investors can get both additional yield and geographic diversification by investing in foreign telecommunications companies. For high yield, geographic diversification, and the best growth opportunities, however, we must look to the emerging markets.

Several of the companies I featured in my last piece on foreign telecoms have substantial exposure to emerging markets. Telefonica (NYSE:TEF) gets about 40% of its revenues from Latin America, which is the company's growth engine. Vodafone (NASDAQ:VOD) serves more countries than any other wireless carrier. This article, however, will focus on companies whose primary focus is in emerging markets. It is a sample of emerging markets companies whose stocks trade on U.S. exchanges and is not intended to be comprehensive.

The Philippine Long Distance Telephone Company (NYSE:PHI) is the largest telecommunications company in the Philippines. Each American Depository Receipt (ADR) represents one common share. It has paid dividends in the last twelve months of $4.45, which equals a current yield of about 7.5%. The fiscal 2011 earnings per share were 163 Philippine pesos, which at current exchange rates is $3.82. This means the dividend payout ratio is 116% based on net earnings. Philippine Long Distance has 2011 net profits of 31.637 billion pesos, depreciation and amortization costs of 27.957 billion pesos, impairments of 8.47 billion pesos, and capital expenditures of 31.236 billion pesos. There were repairs and maintenance costs of about 10.4 billion pesos, but these were accounted for in the net income figure. The annual report breaks down changes in property, plant, and equipment by business segment, and has one category for "property under construction." For this analysis I took that amount to be capital expenditures aimed at growth, while capital expenditures in the other segments were maintenance capital expenditures. This is of course only an approximation, but it yields owner earnings of about 60 billion pesos. This is $1.4 billion or about $7.20 per share. That means the dividend payout ratio on owner earnings is 61.8%, which is high but more reasonable than that based on net earnings.

With Argentina's seizure of its leading energy company YPF (NYSE:YPF), investors have become increasingly concerned over the possibility that Argentina may seize additional companies, including Telecom Argentina (NYSE:TEO). In the meantime, however, Telecom Argentina paid $1.61 in dividends in the past twelve months and had earnings of $2.79 per ADR (1 ADR of Telecom Argentina corresponds to 5 Argentinean shares). That's a dividend payout ratio of 58%. With my estimate of maintenance capital expenditures, Telecom Argentina reported owner earnings of about $3.10 per share in 2011, giving it a dividend payout ratio based on owner earnings of 52%.

Telkom Indonesia (NYSE:TLK) paid dividends in the last 12 months of about $1.36 per share for a dividend yield based on the current share price of 4.0%. Telkom Indonesia reported 2011 earnings of $2.47 per share giving a dividend payout ratio of 55%. Telkom Indonesia is growing sales at a slower pace than Telecom Argentina, so I estimate a higher percentage of maintenance capital expenditures. This leads to an owner earnings level of $2.82 per ADS and a dividend payout ratio of 48%.

Vivo (NYSE:VIV), formerly known as Telefonica Brasil is a subsidiary of Telefonica since Telefonica's acquisition of Vivo in 2010. Vivo represents about 21% of Telefonica's Latin American operating earnings and 11.6% of Telefonica's overall operating earnings. Telefonica is the majority shareholder of Vivo with 74% of the outstanding common and preferred shares, but individual investors can still invest in the outstanding shares. Each online source seemingly reports a different dividend, but Vivo's annual report states that the 2011 dividend per ADR was $2.79 at current exchange rates, for a yield of 9.7% and a payout ratio based on net earnings of 109%. Vivo spent significantly more on capital expenditures in 2011 compared to 2010 or 2009 to enable growth of its businesses, and so I more heavily weighted 2010 and 2009 in my calculation of owner earnings. My estimate of 2011 owner earnings for Vivo is $3.30 per share, and my estimate for the dividend payout ratio based on owner earnings is 85%. This is extremely high, but mitigated by the fact that only 26% or so of the dividends are paid to common shareholders. The rest is free to be reinvested in Brazil or other countries for the benefit of Telefonica shareholders.

Emerging markets in general have higher long-term growth rates than the United States or Europe. Investors seeking yield and growth may look towards telecommunications stocks in emerging markets. I've profiled a few here and given my estimate of each company's ability to pay its dividend using a better metric-payout ratio based on owner earnings-than is commonly used. This is only a starting point for these investments, but I hope you find this methodology useful.

Disclosure: I am long TEF. I may buy shares of VIV or buy additional shares of TEF in the next 72 hours.

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