Should You Add These Four Stocks to Your Watchlist?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Just the mention of anything international in today's market tends to make investors nervous. Companies that operate overseas, and particularly in Europe, seem to be fraught with turmoil. When you mention international telecommunications providers, many investors immediately think of Telefonica (NYSE: TEF) and how their huge dividend was recently turned to dust. However, not all international companies are created equal, and sometimes investors sell in fear, which can create an opportunity.
It should come as no surprise that many international stocks are selling for prices well off their 52-week highs. On a regular basis I run a screen using the Fool.com CAPS Screener to find stocks that are at least 20% below their 52-week highs. Though there is no guarantee that this 20% “discount” has created a bargain, I like the fact that at the very least I'm paying less than investors did in the last year. Of course, there could be a good reason these stocks are selling for less than before. In the telecom sector, four different international names popped up as being at least 20% below their 52 week high. The four companies are France Telecom (NYSE: ORAN), NTT DoCoMo (NYSE: DCM), Telefonica Brazil (NYSE: VIV), and Telefonica.
Each of these companies has its own strengths and weaknesses, but I've found a few ways to directly compare them as investments. Since many investors buy stock in just one company to represent an industry in their portfolio, I feel like comparing each company using the same metric should lead us to the best value. It's no secret that some of these companies face significant headwinds from political unrest due to economic instability, but in the long run their ability to attract new customers and increase the revenue from each customer is what drives their earnings. If we can find the company with the best combination of growth, yield, balance sheet, and margins, we should have a winner on our hands.
I'll start where many people start when it comes to telecom investments: with their yield. France Telecom is the unquestioned leader when it comes to yield with a trailing yield of about 14%. However, if you look at the company's last full year, their free cash flow payout ratio was 71.11%. Looking at the company's current quarter, however, they reported negative free cash flow. Investors should take France Telecom's yield with a grain of salt. Telefonica currently pays no yield, which leaves NTT and Telefonica Brazil and their yields of just over 4%. NTT is the dominant wireless operator in Japan, and Telefonica Brazil is a large wireless and wireline operator in Brazil. The difference is, where NTT pays a 4.47% yield and has a free cash flow payout of about 35.5%, Telefonica Brazil pays roughly 4.14% and has a payout of 154%. NTT has also been raising its dividend while Telefonica Brazil's dividend has been all over the place. I give NTT the edge with its respectable dividend and reasonable payout ratio. If it can be maintained, France Telecom's dividend is tempting. (France Telecom – 3, NTT – 4, Telefonica – 1, Telefonica Brazil – 2)
While a company that pays a dividend is great, if they aren't growing cash flow may decline and the dividend could be in trouble. While history isn't necessarily a predictor of future results, I feel more comfortable accepting analysts' estimates for future growth if I know the company has posted good results in the past. Based on net income and operating cash flow growth, take a look at how each company has fared over the last three years:
You can see that Telefonica Brazil has been growing very fast, and then there is a big drop off. France Telecom loses this one, as their net income and operating cash flow have declined at a higher rate than their competition. (France Telecom – 1, NTT – 3, Telefonica – 2, Telefonica Brazil – 4)
Though none of these companies will win a competition for the most exciting growth prospects, investors still want earnings growth. This is where if you believe analysts, Telefonica should handily beat its competition. Analysts are calling for over 15% growth at Telefonica, 7% growth at NTT, 2.3% growth at Telefonica Brazil, and negative 1% growth for France Telecom. The fact that these companies all sell for between 6 and 11 times forward estimates means that the highest growth rate wins the race. (France Telecom – 1, NTT – 2, Telefonica – 4, Telefonica Brazil – 3)
One additional way investors can compare companies in the same industry is by looking at their margins. Since telecoms have to spend a lot on network upgrades, I prefer to use the EBITDA margin to level the playing field. Each of these companies has similar margins, with NTT coming in the highest at 36.77%. Telefonica Brazil just released earnings and reported a margin of 34.4%, which leaves Telefonica at 33.09% and France Telecom at 31.72%, our laggards. (France Telecom – 1, NTT – 4, Telefonica – 2, Telefonica Brazil – 3)
Last but not least, we need to look at the relative strength of each company's balance sheet. Using the debt-to-equity ratio, we see that Telefonica is the most highly leveraged at 2.81, and France Telecom isn't too far behind at 1.2. NTT and Telefonica Brazil are in a compeltely different class with debt-to-equity ratios of just 0.04 and 0.10 respectively. As we saw with Telefonica's dividend cut, too much debt can force a company into hard choices. In my opinion, the less debt the better. (France Telecom – 2, NTT – 4, Telefonica – 1, Telefonica Brazil – 3)
When we add up the scores, France Telecom scored an 8, NTT scored a 17, Telefonica scored a 10, and Telefonica Brazil scored a 15. The totals really shouldn't be much of a surprise. NTT offers the safest dividend, a respectable growth rate, and the best EBITDA margin and balance sheet. If there is an argument to be made for another company, I believe if Telefonica can get their debt under control this could be a good turnaround play. I wouldn't bet on France Telecom at this point. Their 14% dividend could be a problem, and with analysts calling for negative earnings growth there wouldn't be much left if this dividend were cut further. Telefonica Brazil is an interesting story as the company has been growing like gangbusters, but analysts don't see this continuing. With a similar yield to NTT but lower growth and a lower margin, Telefonica Brazil has a hard comparison to our leader. I would suggest adding one of these companies to your watchlist, and see if you can dial up profits for your portfolio.
MHenage 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!