Which Telecoms to Buy Now?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

These days, whenever I do a screening to find investment opportunities in companies with high dividend yields and high operating cash flow, telecom companies always come up. The high dividend yield may be due to the fact the telecom companies have experienced a large decline in their stock prices. In addition, telecom companies seem to be a cash cow businesses, but many of them leverage heavily. That is why we need to select the most undervalued telecoms with the least leverage and sustainable dividend yield.

Today I will look at several fixed line and mobile operators in different developed and emerging markets including Telefonica (NYSE: TEF), France Telecom (NYSE: ORAN), BT Group (NYSE: BT) and VimpelCom (NASDAQ: VIP). Those telecom companies have experienced a large downfall in their stock prices in the last 5 years.

<img src="/media/images/user_14219/screen-shot-2012-10-22-at-111655-am_large.png" />

In the last 5 years, all four companies have lost 44% to more than 60% of their market value in the stock market. BT is the best performer, with only 44% lost, whereas France Telecom is the worst one, with a nearly 63.4% reduction in its stock price.

Are those stocks value plays or value traps? And what is the best stock to consider among the four?

In terms of the market capitalization, TEF currently has the highest market value, of $63.9 billion, whereas VIP has the lowest one, of $18 billion. The market capitalization of FTE and BT are $33 billion and $27.1 billion respectively.

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>FTE</strong></p> </td> <td> <p><strong>BT</strong></p> </td> <td> <p><strong>VIP</strong></p> </td> <td> <p><strong>TEF</strong></p> </td> </tr> <tr> <td> <p><strong>Operating margin (%)</strong></p> </td> <td> <p>16.2</p> </td> <td> <p>15.2</p> </td> <td> <p>-7.9</p> </td> <td> <p>13.8</p> </td> </tr> <tr> <td> <p><strong>Net margin (%)</strong></p> </td> <td> <p>8.23</p> </td> <td> <p>10.4</p> </td> <td> <p>2.63</p> </td> <td> <p>6.63</p> </td> </tr> <tr> <td> <p><strong>ROE (%)</strong></p> </td> <td> <p>13.28</p> </td> <td> <p>124.3</p> </td> <td> <p>4.09</p> </td> <td> <p>21.04</p> </td> </tr> <tr> <td> <p><strong>Dividend yield (%)</strong></p> </td> <td> <p>12.7</p> </td> <td> <p>3.7</p> </td> <td> <p>3.4</p> </td> <td> <p>11.09</p> </td> </tr> <tr> <td> <p><strong>Interest coverage</strong></p> </td> <td> <p>3.9</p> </td> <td> <p>4.7</p> </td> <td> <p>1.5</p> </td> <td> <p>2.8</p> </td> </tr> <tr> <td> <p><strong>Financial leverage</strong></p> </td> <td> <p>3.32</p> </td> <td> <p>18.5</p> </td> <td> <p>3.37</p> </td> <td> <p>5.96</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>6.9</p> </td> <td> <p>8.9</p> </td> <td> <p>31.6</p> </td> <td> <p>10.8</p> </td> </tr> </tbody> </table>

Among the four, FTE had the highest operating margin, of 16.2%, a little higher than BT and TEF of 15.2% and 13.8% respectively. Only VIP produced operating losses. BT delivered the most spectacular three-digit return on equity, but its high return on equity was contributed by the high leverage level. Indeed, BT had the highest financial leverage, of 18.5x. Its leverage was more than 3 times compared to TEF’s, and more than 6 times compared to FTE’s and VIP’s. However, its interest coverage of 4.7 was also highest among the four, citing that BT was quite comfortable with its ability to service its debts. 

For dividend yield, FTE’s and TEF’s investors enjoyed the best double-digit dividend yield. Both companies had comfortable interest coverage ratio. Its return on equity ranked second to BT with more than 21%, but it only employed a third of financial leverage compared to BT. 

VIP seemed to be least performing, with negative operating margin, low net margin and return on equity. Its interest coverage was also the lowest, of 1.5x. Maybe the low profit has pushed its P/E up to 31.6x, much higher than that of average industry’s valuation is 25.4x P/E.

My Foolish Take

In the telecommunication industry, I would prefer FTE and TEF, as the two companies had a good operating and net margin with good return on equity. Those two employed reasonable amount of leverage and they are in a comfortable position to cover its interest expense. And the market values them cheap even though they paid out double-digit dividend yield. Personally, I think FTE and TEF could fit into investment portfolios of both income and long-term investors. 


hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of France Telecom (ADR). Motley Fool newsletter services recommend France Telecom (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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