Telefonica A Dividend Stock Out Of Favor

Jun. 4.12 | About: Telefonica S.A. (TEF)

Telefonica, said on Thursday that it planned to sell a stake in its German carrier, O2 Germany, and would weigh similar sales at some of its Latin American carriers as it looked to trim debt following a credit review.

Telefonica had not yet disclosed details on whether it would seek a full or a partial IPO. for O2 Germany.

Overview

Telefonica (NYSE:TEF) made several acquisitions in Latin America and Europe and thereby reduced the dependence on Spain (75% of revenue now outside Spain) and increased its presence in wireless and in emerging markets.

Net debt increased related to the acquisitions and Telefonica announced steps to improve its balance sheet and avoid further credit rating downgrades by the agencies (on 24 May, S&P cut Telefonica's rating to BBB).

The timing for IPOs is not good as valuation levels are low. Overall, the positive elements of the measures should outweigh the negatives (e.g. dilutive effects of scrip dividend) and it is positive that the company is tackling its debt problems. But the main trigger for the stock remains a stabilization of the domestic business.

Q1 results were mixed with revenue slightly better than expected while EBITDA missed estimates by 3% due to weakness in Spain and the UK. Overall few to cheer about but analysts have already lowered their expectations and market sentiment toward the stock is already low. Macro and sovereign risk is difficult to access but medium-term prospects remain favorable, driven by Latin America.

The stock has severely suffered year-to-date due to weakness of its domestic operations but also related to sovereign debt concerns as Telefonica is still seen as a proxy for the Spanish IBEX.

Investment Case

The announced steps are a clear deleveraging signal to improve its balance sheet and avoid further credit rating downgrades by the agencies.

The new remuneration policy mix with a higher scrip dividend lowers the total cash payouts, which is positive for the company but negative for shareholders.

Concerning the IPO, investors could be less positive. To float the German business makes sense as Telefonica may benefit from the strong operational performance and a listing could pave the way for a sale/merger with E-Plus. E-Plus is from Dutch telecom operator (OTCPK:KKPNY).

The potential IPO of the Latin America assets is more mixed as Telefonica would lose part of its future growth engine. 70% of the company's Latin America EBITDA is generated by Brazil, Argentina and Venezuela. Telefonica could focus the sale of other less appealing assets.

However the timing for IPOs is not good as valuation levels are low. Overall, the positive elements of the measures should outweigh the negatives (e.g. dilutive effects of scrip dividend) and its positive that Telefonica is tackling its debt problems. But the main trigger for the stock remains a stabilization of the domestic business.

The stock could be a value play for investors seeking high dividend (around 10%).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.