Don't Buy Into Telefonica's Valuation

| About: Telefonica S.A. (TEF)

This article was revised and republished on Feb. 4, 2012.

Telefonica (NYSE:TEF) is a Spain based telecommunications company that offers services in Europe and Latin America. In the last year, investors punished this company due to financial troubles in Spain. In the last year, the stock price moved from $25.42 to $17.65, a price drop of 30.57%. While the stock is punished heavily and it looks like it offers a solid valuation, I am still not convinced about this company's valuation. In this article, I will compare Telefonica with 3 competitors from 3 different countries in order to assess its valuation. These 3 competitors are Verizon (NYSE:VZ) from US, France Telecom (FTE) from France, and Deutsche Telekom (OTCQX:DTEGY) from Germany.

First we will look at P/E excluding extraordinary items. In this metric, Telefonica is a clear winner with a P/E ratio of 5. France Telecom comes second with a P/E ratio of 10 and other two companies are far behind of these two.

The next metric we have is P/E normalized. Many times P/E ratios are adjusted statistically in order to control for fluctuations in the market over a short period of time. In this metric, Telefonica is a clear winner once again. The company has a normalized P/E ratio of 2.8. The closest competitor is France Telecom once again, with a normalized P/E of 7.

When we look at Price to Revenue ratios, we have a different winner. France Telecom's price to revenue ratio is 0.7, Deutsche Telekom's ratio is 0.8. The other companies have a price to revenue ratio of 1.0.

The next metric is Price to Cash Flow. In this metric, France Telecom has a ratio of 3.1, Deutsche Telekom has a ratio of 3.4 and Verizon has a ratio of 4. Telefonica comes last, with a price to cash flow ratio of 4.3.

Telefonica is in the danger zone when we look at total debt to equity ratios. In this metric, the three competitors range between 1.1 and 1.5 whereas TEF's ratio is 3.4. In this metric, Telefonica seems far behind its peers.

Our next metric is Price to Cash ratio. In this metric, Telefonica is a winner by a large margin. The other 3 competitors have ratios ranging from 6.06 and 8.68 whereas Telefonica's ratio is 3.61.

In our next metric, Price to Book value, we have 3 companies with very similar numbers. In this metric, Deutsche Telekom has the lowest ratio with 1.06, France Telecom has the second lowest ratio with 1.09 and Telefonica comes third with a ratio of 1.13. Verizon's price to book value is 2.98.

As mentioned above, Telefonica's high debt levels put it in the danger zone. Let's take a closer look at the company's debt problem. The company has current liabilities of over 33 billion Euros, which equals $41 billion.

The company's total long term debt has been rising steadily since 2008. Currently the company's long term debt sits right below 54 billion Euros, equaling $67.5 billion.

Telefonica's total debt is another variable that's been rising since 2008. Currently the company has a total debt of 61 billion Euros, equaling $76.25 billion. In the last 3 years, the company's debt increased by an annual rate of 5%. While the company could be paying off its debt, it chooses to pay high dividends, currently yielding 12%.

The company's total liabilities are 107 billion Euros ($134 billion) and it's been rising since 2008.

It seems like despite plunging by 30% over the last year, the stock still does not offer that good of a valuation. The company could increase its valuation by increasing its cash flow and decreasing its debt levels significantly. I rate Telefonica as hold until the company starts making progress in paying off its debt. On the other hand, I rate France Telecom as buy as it seems to offer the best valuation among the 4 stocks mentioned in this article.

Source: For the numbers I used Scottrade and Morningstar as my sources.

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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