All Eyes Should Be On Financing For Telefonica's Q1 Results

| About: Telefonica S.A. (TEF)

The most troubling statistic for any Telefonica (NYSE:TEF) investor should be the company's current ratio. According to the most recent balance sheet, the company has current liabilities of 32.5B Euros and current assets of 20.8B Euros, and therefore a current ratio of only 0.64. Anything below 1.0 is approaching the speculative range. By definition current liabilities are payable within one year, so within that timeframe, Telefonica needs to close the gap of 11.7B Euros. This could be done in a number of ways. But, assuming no dramatic change in the company's working capital policies, the lion's share of the company's ability to finance that gap will come from the roll-over of the 10.7B Euros in current debt or from a reduction in the company's payout policy.

If the company is unable to roll-over that debt, the deficit will probably have to come out of shareholders pockets, either directly via a reduction in the dividend payout, or indirectly through the issuance of more shares. Last year the company paid 7.6B in dividends, and that could nearly cover the difference.

Therefore for Q1, all eyes should be on the company's financing activities, especially for shareholders most concerned with the safety of the company's dividend.

According to the latest information on the company website, the corporation so far has raised just under an additional 2B Euros. That leaves 9B to go. On May 11th, we will see how far the company has come in terms of raising the financing it needs to sustain its shareholder remuneration policy for the coming year.

Another important factor to watch is the average rate of interest that the company pays on its new issuances of debt. For 2011, net financing expense stood at 2.9B Euros on a net debt of 56.4B Euros, but that figure could increase if the company's cost of borrowing rises. The average interest rate paid in 2011 was 4.91%, down from 5% in 2010.

While the ability to raise a large amount of debt would be a welcome sign of financial strength, perhaps the most welcome result from the company would be, paradoxically, a temporary reduction in the dividend. The core operations of Telefonica are sound, and relative to earnings potential, the company is a bargain. In fact, the company's largest risk comes from its financing situation. By using its dividend cash to shore up its financial strength, the company may do more for shareholders than by simply issuing a cash payment. For management, it is certainly worth a thought.

Looking at the larger debt picture, there is less cause for concern. With debt at nearly 70% of the capital structure, the figure is certainly high, but for a utility style company, such levels of debt can actually be a good thing. Benjamin Graham and David Dodd write in Security Analysis that "For most public utility companies... a substantial debt is warranted by the inherent stability of their operations, and the gain to the stockholders from the use of low-cost money... Thus we should recommend as a preferable capital structure for utilities the simpler combination of about two-thirds in debt and one-third in common-stock equity."

Of course, even if such levels of debt are acceptable, a company so reliant on debt financing should certainly focus on maintaining its access to credit markets, and with short term financing in question, that focus at Telefonica might be weaker than desired. Both S&P and Moody's have negative outlooks for the company's credit ratings, and their analysts will be watching the company's Q1 financial position very closely. Investors in Telefonica should watch even more closely.

Disclosure: I am long TEF.