Is Cellcom Israel Really Undervalued?

| About: Cellcom Israel, (CEL)

Cellcom Israel (NYSE:CEL), Israel's second largest cellular device carrier, has a mixed valuation. Cellcom has a price to earnings ratio (P/E) of 3.41, one of the lowest in the telecommunications industry. In fact, Cellcom's P/E is nearly seven times lower than its industry's average of 24.6 . Along with a low P/E ratio, Cellcom's fiscal year sales were $1.65 billion, more than double its market capitalization of $577 million. In addition to their sales and earnings, Cellcom also pays a hefty 28% dividend. However, Cellcom has collapsed for many reasons.

Why Cellcom's Stock Price has Receded

Cellcom Israel's stock price collapsed due to new competition in Israel's cellular market, which has eroded margins and reduced the number of Cellcom's subscribers.

Depreciated Stock Price

Pros: Over the last year, Cellcom's stock price has dropped 77.18%, while its income and dividend rate have not dropped by the same factor.

This has created an very low price to earnings ratio and very high 28% dividend yield. Along with its depreciated stock price, Cellcom has a price to sales ratio of 0.4, lower than the industry average of 1.1 by almost three times; a positive 0.5% revenue growth, the industry average is down 1.7%, and a 10.6% profit margin, more than doubling the industry's profit margin of 4.1%.

Cons: Cellcom's stock has collapsed due to many financial elements. Cellcom has a debt/equity ratio of 21.2, about 8.5 times more than the industry's average of 2.5. Cellcom has a Price/Book value of 8.8, 5.5 times larger than the telecom industry average of 1.6 and has a earnings per share growth of -6.00%, 10.5% less than the industry's average of 4.5%. Cellcom's revenue and income declines are suppose to escalate, causing very negative prospects for Cellcom's future.

A quote by Cellcom's Chief Executive Officer, Nir Sztern...

The intensified competition which characterized this past year, led to a continued reduction in service revenues. The decline in service revenues will continue in the following quarters and may even escalate as a result of the new competition, and so, we intend to implement additional efficiency measures regarding costs and merger synergies, but we estimate that these measures will only partly compensate for the decrease in revenues.

... brings expectations for Cellcom's stock price to even lower standards. When a CEO openly states that losses will further escalate, it typically happens.

Heavily Funded Dividend

Pros: To any investor, making a profit on your investment is your goal. Investing in a company with large dividend and payout ratio is an effective method of meeting this goal. Cellcom has a superb dividend, larger than any other telecom company except its major competitor Partner Communications (NASDAQ:PTNR) and is larger than France Telecom's (FTE) giant dividend by more than 12%. Cellcom's dividend has increased 80% over the last quarter. As a result of the hefty dividend, investors could use the dividend as a hedge against stock depreciation. Even if the stock drops, Cellcom's dividend could help profit. If the share price increases, Cellcom's dividend will greatly boost investment returns. As an offset and a boost, Cellcom's dividend can be a major upside when investing.

Cons: Large dividends are usually a positive component of a stock, that is when it doesn't get in the way of how the company functions. At Cellcom Israel, dividends seem to prioritize over many other aspects in the company. Within Cellcom's first quarter release it exclaimed that 75% of all of Cellcom's income is given to shareholders in the form of a dividend. With the amount of debt and necessary improvements to compete, can they spare 75%.

Even with these challenges, somehow Cellcom decided to increase their dividend rate by 80% ($0.59) in the first quarter, after their earnings dropped a significant 43.5% and their stock price has dropped more than 50% between quarters. If Cellcom decides to lower their dividend it may lower the stock price for that quarter, but it will give Cellcom additional cash to improve. Recently, Cellcom has been met with new competition. As the second largest wireless carrier in Israel, Cellcom has been part of an oligopoly for more than ten years. Cellcom's oligopoly of cellular carriers been given the reputation of selling overpriced plans with dated networks since the oligopoly's beginning in 1999.

In 2012, Golan Telecom and HOT Mobile entered the Israeli telecom market, with the goal of collapsing the oligopoly. So far their plan has worked effectively. The new competition has a 4G network, much faster than the oligopoly's 3G, and lower pricing plans. With a competitive edge, HOT Mobile and Golan Telecom have drawn thousands of Cellcom's subscribers to their phone plans. In return, this has caused Cellcom's user base to reduce by 1.7%, earnings to recede, and stock price to tumble.

To get Cellcom enough cash to get out of its difficulties, it must cut expenses and increase funds by lowering its dividend. Although this could hurt short term shareholders, it is one of the only ways the company can get funding to improve. In order for Cellcom to compare to the new competition it needs to lower their dividend, improve their network to 4G, use funds from dividend cuts to pay off debt, and drop their pricing. In reality, cutting Cellcom's dividend could be a solution to making Cellcom compare to their competition.

New Competition

Pros: Cellcom Israel's new competition is forcing them to improve. The competition has dismantled the unhealthy, oligopoly based economy and has promoted healthy competition.

Cons: Cellcom's new competition is a major downside to investors and the future of the company. If Cellcom continues to not meet or exceed the pricing or services of its new competition, their users will likely go elsewhere. Based on a recent survey, in the last two months Cellcom has lost 57,000 subscribers. If subscribers continue to dwindle, Cellcom could see further losses in revenue in the second quarter.

In conclusion, Cellcom has an opportunity to improve and meet or exceed their competition. Cellcom can cut its dividend and use the new funds to improve and meet the levels of competition. On the other hand, Cellcom could be slow to improve and continue to be overtaken by fast growing competition. As a whole, it is difficult to conclude exactly where Cellcom will go in the future.

Industrial averages involve the telecom industry worldwide and include AT&T Inc. (NYSE:T), China Mobile (NYSE:CHL), Vodafone (NASDAQ:VOD), and every other public telecommunications company.

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

Disclaimer: I have not received compensation directly or indirectly for expressing any recommendation in this report. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

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