Telefonica: A Defensive Stock to Play the European Debt Crisis

| About: Telefonica S.A. (TEF)
The European debt crisis has been repeatedly dominating world headlines for months, if not longer. Although the recent debates over the U.S. debt ceiling have occupied media recently, the debt troubles in Europe remain far from resolved. It seems as if every day a new headline or update comes out that batters European stocks once again. This ongoing debt crisis has caused many European stocks to decline. In many cases, these price declines are unwarranted. There are many European stocks selling for prices that should allow investors to profit once this debt situation is ultimately resolved.
I recommend buying dividend-paying stocks to turn a profit here. The reason is that these stocks pay you to own them. It is difficult to reliably predict when the European debt crisis will be resolved and the possibility certainly exists that there will be more market-negative events out of the region until it is ultimately resolved. Further negative news could push your Eurozone stocks down further. The prospect of receiving a solid dividend can make it much easier and more palatable to ride the rapids. It is important to remember that most European stock dividends are subject to withholding taxes. The major exception is companies based in the United Kingdom, which have no withholding taxes for U.S. investors.
This article is the first part of a three part series analyzing companies that could be profitable opportunities for investors willing to invest in Europe. The first company that will be analyzed is a telecommunications company with a very high dividend yield.
Telefonica S.A. (NYSE:TEF) is the largest wireline and mobile phone carrier in Spain. Spain is one of the European countries known as the P.I.I.G.S. at the center of the financial and economic problems in Europe. So why would you want to own the Spanish phone company? For starters, Telefonica operates in more countries than just Spain. Telefonica owns the Movistar mobile phone operator, one of the largest phone carriers in Latin America. Telefonica, under the Movistar name or through other wholly owned brands, is the largest mobile communications provider in Brazil, Peru, Venezuela, and Chile. The company is the second largest mobile phone operator in Mexico although there are indications that Telefonica is successfully capturing market share from number one provider America Movil (NYSE:AMX).
Telefonica’s stock has not performed particularly well since the start of the European debt crisis. One reason for this is the company’s Spanish roots. There is a definite feeling of near panic in the markets with just about anything connected to Europe and the P.I.I.G.S. in general. Telefonica is also a major component of most index funds focused on Spain. Many investors have been selling Spain and thus forcing index funds to sell. This forced selling is significant enough to drive down the share price. In the case of Telefonica at least, that fear seems to be misplaced. Telefonica will also be taking a large 2.7 billion euro charge this year due to a layoff in Spain. The company will take the entire charge this year, which will depress earnings. While this will actually improve the company’s earnings going forward, this charge is likely having a negative effect on the stock price. Once again, this strengthens the argument to buy now while the stock is cheap.
In addition to the company’s substantial presence in Latin America, Telefonica also holds several other investments that could prove quite profitable going forward.
  • Telefonica owns 10% of China Unicom (Hong Kong) Limited (NYSE:CHU). China Unicom is a growing company offering wireless, fixed land-line, and additional services to mainland China. According to Yahoo Finance, China Unicom is a $47.19 billion market cap company at the time of writing. That makes Telefonica’s stake worth approximately $4.7 billion.
  • Telefonica owns approximately 10% of Portugal Telecom SGPS SA (NYSE:PT). A major telecom company in Portugal? Really? Portugal is another one of the P.I.I.G.S. countries and has been having problems recently with the austerity demands of the E.U. However, Portugal Telecom has an international presence much like Telefonica does. Portugal Telecom offers telephone, wireless, fixed line, and broadband services to consumers and businesses in Portugal, Brazil, and Africa. This company has a significant presence in growing economies. At the time of writing, Portugal Telecom is a $7.37 billion company by market cap. This makes Telefonica’s stake worth approximately $737 million.
  • Telefonica owns approximately 10% of Telecom Italia SpA (NYSE:TI). Telecom Italia is the largest telecommunications company in Italy. Italy is another of the P.I.I.G.S. countries but the story here is in some ways similar to the other telecomm companies discussed in this article. Telecom Italia operates primarily in Italy and Brazil. The company operates landline telephone services in Italy, GSM mobile phone services in Italy and Brazil, and DSL internet and telephone services in Italy and San Marino. Telecom Italia also owns a major Italian television company and Olivetti, a manufacturer of computer peripherals. Telecom Italia also owns a major stake in Telecom Argentina. Telecom Italia is a $22.99 billion company by market cap which makes Telefonica’s stake worth approximately $2.3 billion.
With the exception of China Unicom, every company in Telefonica’s portfolio as well as Telefonica itself could see revenue contraction from European austerity. This risk looks to be priced into the stocks of every one of these companies today. It is also likely that this risk is overblown. I expect Europeans who are suffering from reductions of income due to the fiscal and economic problems there to cut out and reduce their spending in other areas long before they reduce their spending on wireless services and internet access. As Warren Buffett has said, “Be greedy when others are fearful.”
Telefonica has a very high dividend. The Board of Directors is committed to paying a dividend of 1.60 euro per share for 2011. This dividend will be paid in two installments. The first will be paid in November of this year and the second will be paid in May 2012. This is an increase of 14.3% from the 1.40 euro dividend paid during the previous year. Additionally, the company intends to increase its dividend to 1.75 euro in the 2012 fiscal year and set that as a stated minimum dividend going forward. 1.60 euro is equivalent to $2.30 at the current exchange rate and 1.75 euro is equivalent to $2.52 at the current exchange rate. That gives Telefonica dividend yields of 10.5% and 11.5% for 2011 and 2012 respectively. This dividend is subject to a 19% Spanish withholding tax but it is still a very solid yield net of that.

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

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