Telecom Growth on the Cheap

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Due to the persistent European debt crisis, and the fact that many European blue-chips are now trading at very low multiples, Europe may turn out to be the place for bargain hunting this holiday season. Many investors are understandably still skeptical about investing in Europe at the moment, which is why I would generally recommend consumer staples and utility/telecom stocks at the moment. Telefonica (NYSE: TEF), a Spanish telecom giant, is simply very cheap at the moment. Additionally, the company is working on shoring up its balance sheet, which should lead to increased investor confidence.

Telefonica is one of the world’s largest telecom companies, and operates mainly in Europe and Latin America. Their brands include names such as Movistar, O2 and Viva. The company, founded in 1924, has over 280,000 employees and a market cap just shy of $60 billion. It is no secret that the company has fallen on rather hard times recently, with consumer spending in Europe slowing down and a lot of debt on the balance sheet. The company, which yielded over 10%, has suspended dividend payments this year in order to begin tackling its huge debt. It is estimated that this move will save the company around 6 billion Euros, which isn’t going to pay off their debt load estimated at around 58 billion Euros, but is definitely a good start.

Telefonica has also undertaken a number of other measures in order to curb their debt issues. One of these is the listing of their German O2 unit, which is expected to raise about 1.5 billion Euros in capital. O2 shares saw strong interest during their IPO on October 30, Europe’s biggest since Bankia was listed in 2011. Telefonica Deutschland is now trading above its IPO price.

Another measure undertaken is its sale of the Atento call center business to Bain Capital, a US private equity firm who paid around a billion dollars for the call center operations. Investors were apparently pleased at this news, with shares up over 5% some days after the news. Telefonica has also announced to reinstate their dividend in the second half of 2013 at a yield of around 7% annually.

Because the company has a strong presence in Latin America, a huge growth market for telecommunications, it was able to offset some of its losses among its European divisions. Activities in this region should continue to propel growth in coming years, which should also secure the company’s cash flow and ability to pay dividends. Also, investor confidence has been boosted by recent measures to raise capital and curb debt.

Based on valuations, the stock is a bargain at the moment. The P/E stands at only 10.5x earnings and the forward P/E is even lower at 6.63x. The stock is priced at 2.19 to book and only 0.71 to sales, both of which are lower than the industry average. The firm has a nice return on equity of 19.46% and a comfortable operating margin of 16.95%. The stock is certainly cheaper than competitors such as AT&T (NYSE: T) and Deutsche Telekom (NASDAQOTH: DTEGY.PK). AT&T trades at a high multiple of about 46x earnings, 1.57 to sales, and has a return on equity of only 4.36%. Deutsche Telekom has an even higher P/E of 63.4x earnings, and an even lower return on equity of 2.23%. Looking at these numbers, there is no question about what represents the cheaper telecoms play at the moment.

Telefonica is a global telecoms giant with a strong presence in the growth markets of Latin America. Although they have been plagued by a number of problems recently, in no small part due to the European debt crisis and the abysmal state of the Spanish economy, the firm has displayed a commitment towards lowering its debt and shoring up its balance sheet. With the planned return of dividends in 2013, I believe the stock represents a strong growth play, at a very low price.


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