In the wake of Telefonica S.A.'s (TEF) dividend cut last week - the first since the Spanish Civil war of the 1930s - shares have been bouncing above the $11 level, cutting through $11.50 briefly today on a 7% jump. Clearly, the impending dividend cut had been expected by market investors and the cost of the cut to share value had already been priced into the shares. I was bullish on TEF in May and am even more bullish today: this is a Spanish equity for the long term now with even more compelling long factors in its favor. Here's why:
As a shareholder who held some belief in the sustainability of TEF's dividend yield, I was initially disappointed in last week's announcement by management. However, after examining all the factors, the prospect of putting valuable and scare company capital to better use persuaded me that management had made a sound decision. As one analysis explains,
As well as cutting the dividend for 2012, Telefonica cancelled its share buyback programme and trimmed top management's salaries, though remuneration remains above industry standards.
The plan will help Telefonica confront its 57 billion euros ($69 billion) of debt, and was welcomed by analysts and rating agencies. The company's shares closed up 3 percent at 8.9 euros, having initially fallen more than 8 percent at the market open.
The firm has taken action ahead of heavy debt redemptions early next year, with a 1.5 billion euro bond maturing on Feb. 14 and a 1.2 billion euro bond repayment due on June 12.
The cost of insuring against Telefonica's five-year debt using credit default swaps (CDS) has jumped around 170 percent in the last year to over 550 basis points.
The firm's CDS has increased 11 percent since the beginning of the month, while Spain has struggled to avoid taking a full-scale sovereign rescue.
Committing this capital to servicing near-term debt obligations and longer-term share buyback programs should certainly comfort shareholders and prospective investors. The potential for capital appreciation in TEF from current $11 levels is profound, and a glimpse at the firm's current financial metrics only justifies this conclusion further.
Operating earnings yield stands at 12.1%, which is very high in the industry and in most indices. TEF price has been battered nearly 50% in the past year and 21.8% in the last quarter, largely as a result of uncertainty regarding future solvency and growth. Now that one of these key factors can be minimized, there's good reason to believe this lost ground will be made up and more. Fundamentally, TEF remains strong. Annual operating earnings per share increased steadily from 2007 to 2011 ($1.94, $2.37, $2.45, $2.77, $3.06), and stand at $1.63 in the trailing 12 months. Over the same period annual revenue increased from $83.058 billion to $84.002 billion, with TTM revenue at $82.376 billion. Net profit on sales was 11.1% in 2007, 13.4% in 2008, 13.3% in 2009, 14.2% in 2010, and 16.6% in 2011, with TTM net profit on sales of 9%. Book value per share in TTM stands at a strong $6.13, and return on equity is a respectable 26.6%.
Competitors and similar firms for peer analysis include Nippon Telegraph & Telephone (NTT), China Unicom (Hong Kong) Ltd. (CHU), BCE Inc. (BCE) , BT Group PLC (BT), CenturyLink Inc (CTL), Chunghwa Telecom Ltd (CHT), America Movil S.A. de C.V. (AMX), NTT DOCOMO, Inc. (DCM), AT&T Inc. (T), Telekonumikasi Indonesia (TLK), Telefonica Brasil SA (VIV), Verizon Communications Inc. (VZ), and others.
With these prospects, I can easily see TEF shares reaching the $14 levels of May and at the very least the $12 levels of late June and early July. The next few months will certainly bring a host of catalytic events, all of which could influence the trading price of TEF shares dramatically in the same way recent share price jumps have been occurring. The Q3/nine months earnings report on November 7, 2012 will be extremely enlightening; I am confident in retaining my long position at least until then. Investors should be well aware of downside risk on these equities, which could include continued European and global macroeconomic deterioration, decreasing or negative European growth rates, or potential default on debt obligations. However, with the dividend cut and M&A division discussions, the freed capital will certainly do a great deal to alleviate the last concern; positive and increasing Latin American growth will likely combat the second; and many analysts are positive about the future of the U.S. and global economy.
On balance, this is a phenomenal equity investment with good prospects for the future. TEF is beginning to get back on its feet, and those who are bullish on the global macroeconomy (or the Spanish economic situation in particular) have a great deal to be optimistic about when it comes to Telefonica. My claim from May of this year remains true: the fundamental value of Telefonica S.A. is higher than its current market capitalization. Thus, brave investors would be wise to take advantage of this opportunity. I would not be surprised to see TEF trading in the $15 range by the end of 2012. Best of luck.
Disclosure: I am long TEF.