A Value Stock with High Growth

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A Solid Strategy

A stock that caught my attention several months ago was Portugal Telecom (NYSE: PT).  At first glance, Portugal Telecom looked like a Strong Buy with a moderate amount of risk.  After all, according to MSN Money’s Financial Highlights, Portugal Telecom pays a dividend of more than 14%, grew revenues at more than 64%, and grew earnings at more than 217%.  Those numbers are, however, a bit misleading. 

On a high level, Portugal Telecom’s strategy seems easy to understand: gain a foothold in high growth markets, increase penetration, maintain share leadership, and deliver outstanding returns.  But don't tie up too many resources in Africa. 

Portugal Telecom’s Medium Term Strategic Objectives include: (1) growing its customer base to 100 million customers; (2) increasing its exposure to international operations to up to two thirds of revenues; (3) reinforcing leadership in all market segments; (4) achieving top-quartile performance in shareholder return and results, and (5) “being a reference in terms of stability.” 

So let’s take a look at the drivers of Portugal Telecom’s strategy.

Domestic and International Business

Portugal Telecom is focused on three regions: Portugal, Brazil – and to a lesser extent – sub-Saharan Africa and Asia in areas such as Guinea-Bissau, Cape Verde, Mozambique, Timor-Leste, Angola, Kenya, the People’s Republic of China, Sao Tome and Principle. 

In Portugal, Portugal Telecom is considered a de facto monopoly.  In fact, Portugal Telecom was the only operator in Portugal until 1994.  Then in 2000 Portugal Telecom became a publicly owned company.  Sure, there is more competition in Portugal than there once was, but Portugal Telecom is still considered a de facto monopoly because it maintains a fairly dominant position in the market.

Because of Portugal Telecom’s scale, growth prospects and starting position, the Brazilian market is Portugal Telecom’s top priority.  That is in sharp contrast to Africa where Portugal Telecom appears to be less confident that the size of prize is worth capturing right now.

Share Leadership

Portugal Telecom does a solid job at nurturing partnerships that focus on developing new solutions and services, collaborating in innovation and R&D, and sharing best practices.    

According to Portugal Telecom’s press release, “In the Brazilian market, PT is present in Oi, the largest telecommunications operator in South America, and in Contax, Brazil’s leading contact center services company.”

Portugal Telecom’s strategic investment in Oi (NYSE: OIBR), for instance, allows Portugal Telecom to secure access to technology, innovation and R&D.  That investment also increases Portugal Telecom’s scale and portfolio of products and services. 

But the key benefit of that investment is that Portugal Telecom is able to leverage Oi’s strong market position and customer base.  Portugal Telecom can capture growth and capitalize on its operational experience in F2M convergence, fixed and mobile broadband, and pay-TV.

It is also worth noting that Portugal Telecom previously held 29.7% of Vivo, which it controlled jointly with Telefonica, until it agreed to sell its stake to Telefonica in 2010.

Shareholder Return

One thing that I love about this company is its publically stated commitment to delivering results for its shareholders.  To that end, delivering a shareholder return in the 1st Quartile is one of Portugal Telecom’s medium term strategic objectives.    

That is reflected in Portugal Telecom’s nice dividend yield of 14.59%.  But the problem that Portugal Telecom faces is one that every telecom company faces: how to allocate capital.  Should Portugal Telecom pay off some of its debt?  Slash the dividend in half (which is still a nice yield)?  Invest in infrastructure and growth?  What about R&D?

All in all, Portugal Telecom has a solid but not great balance sheet.  So the concern that Portugal Telecom may reduce its dividend is palpable.  That said, I do not see Portugal Telecom eliminating its dividend anytime soon.

In addition to the dividend yield, the company’s underlying fundamentals and growth potential suggest that you can expect a reasonable appreciation in the share price of Portugal Telecom.  Strategic partnerships such as Qi provide Portugal Telecom with access to one of the largest and most sought after markets in the world: Brazil. 

3 Reasons to Buy Portugal Telecom

  1. Portugal Telecom has a strong foothold in Brazil.  That is one of the best emerging markets – if not the best – for a telecom company.  For those of you who didn’t know, they speak Portuguese in Brazil, which gives Portugal Telecom a significant competitive advantage.     
  2. Portugal Telecom will likely continue to reward its shareholders with a generous dividend.  Even if Portugal Telecom were to cut its dividend in half the yield would still be around 8%.
  3. Portugal Telecom has demonstrated the ability to successfully leverage partnerships with key institutions and other companies to develop innovative products and services.         

My Foolish Take

On the positive, Portugal Telecom has a strong and growing presence in Brazil, pays a large dividend, has demonstrated the ability to develop innovative products and services, still has a de facto monopoly in Portugal, and is focusing on markets where it has comparative and competitive advantages.

On the negative, the telecom sector is a very competitive sector.  That is why analysts are extremely reluctant to strongly recommend any telecom stock regardless of its fundamentals and growth potential.  In the future, it is possible that Portugal Telecom may either reduce its dividend and/or have its credit rating downgraded.

Overall, I feel that this company has an attractive valuation.  There are, however, significant risks surrounding this company and sector.  That is why I would suggest having a ‘basket’ of a few international telecom companies that have solid balance sheets and attractive dividend yields.   

RyanPeckyno is long Portugal Telecom. The Motley Fool has no position in any of the stocks mentioned. 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!

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