Telefonica Very Attractive After Dividend Cut

| About: Telefonica S.A. (TEF)

Conventional wisdom in the stock market offers that a stock will go up when a dividend is announced, and will go down if a dividend is cancelled. Bucking that trend last week was Telefonica (TEF), which is up some 10% since it announced the elimination of its dividend. I'd have to agree with the market on this one - the absence of a dividend makes this a more appealing stock for investors, for several reasons.

As previously discussed, the biggest risk to Telefonica is its debt load. Since a good portion of that debt is denominated in Euros, and Spain's political outlook remains uncertain, getting this debt to a manageable level should be the highest priority.

Furthermore, as Spain's banks attempt to stave off crises of their own, refinancing obligations due in the near future is likely to be expensive. Eliminating the dividend now affords the company enough capital to repay its obligations to the end of 2013, giving the company a lot of breathing space.

Previously, the company was embarked on a plan to sell "non-core" assets in order to ensure enough capital to meet its obligations. Now, however, it can proceed with asset sales without the pressure of looming obligations. This is bad for the buyers of these assets (who might have been looking for distressed-level pricing), but it's good for shareholders. If Telefonica is not offered good value for its assets, it can walk away.

Finally, not to be overlooked is the fact that dividends trigger taxes. This is even more the case with a foreign stock like Telefonica, as Spain imposes a set of withholding taxes that trim shareholder returns (subject to refundable credits for certain groups of shareholders). In this case, dividends do not simply represent the moving of funds from the shareholder's right pocket to his left, as some cash is siphoned off along the way. Instead of willingly surrendering additional portions of its cash flow to governments, Telefonica would be in a much better position were it to apply the full amount of its cash flow to reduce its debt burden.

With the stock at its current low level relative to earnings, buybacks would make a much more attractive form of returning cash to shareholders once the debt situation is back under control. Until then, investors are offered a chance to hold a delevering company with strong cash flow generation at a low multiple.

Disclosure: I am long TEF.