Cellcom Calling Back Investors?

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

Cellcom Israel (NYSE: CEL) is a communications company in Israel.  Really, there is nothing too exciting about them.  What I mean is, nothing really stands about their business.  They have cell phone plans, internet, TV...you know the normal communications things.  The interesting thing about Cellcom is not the business that they're in, it's the circumstances that led to how their stock price has eroded from it's lofty summit of $35/share in December 2010, to where the price is today. 

Originally, many people (myself included), were drawn to CEL for their historically large dividends.  Many communications companies are able to offer big dividends like Verizon (NYSE: VZ).  Verizon has been, for the most part, very consistent with their dividend.  It has been growing steadily for years and it currently sits at 4.5%.  AT&T (NYSE: T) does them one better with having a consistent (and growing) dividend for over 20 years that currently sits at 5%.  When I started my investment with Cellcom, I believe the dividend was at 8% or so.  That is a really big dividend, and it was sustainable thanks to high profits from lack of competition.  The Israeli government used to allow only a certain number of licenses for communication companies, eliminating many would-be competitors.  When that changed, this stock took a 15 month nose-dive.

News Flash: Cellcom Israel was up by as much as 16% last week.  Quarterly results are in and Cellcom is calling up its old investors to have a party, and they are celebrating Israeli style complete with hummus, couscous, and shakshouka.  But is it really time for investors to party again?  I am not convinced.

The Problem Expounded

I have already mentioned that things have gotten a bit more competitive in Israel.  For a long time companies like Cellcom and Partner Communications (NASDAQ: PTNR) enjoyed a privileged position in the communications market.  It allowed them to do business where others couldn't.  Competition, as most economists will tell you, is what makes prices competitive.  I remember when I was a kid, we had two gas stations in town, one across the street from each other.  Afternoon entertainment in my neck of the woods was going out and watching one station owner lower his gas by a penny to be cheaper than the other guy, only to then have the other guy come out and lower his price by two pennies.  Competition drives prices.

Because Cellcom enjoyed the profits that non-competitive pricing will afford you, then they were able to reward their shareholders with an above industry average dividend.  (Interestingly, Partner never had a consistent nor as high a paying dividend as CEL even though they were in the same boat) The dividend was what Cellcom Israel was all about for me.  That's why I was in; that's why you were in.  Like I said, it looked sustainable.  It was a lot of money in dividends, and who could step in and take that away?

Enter the competition.  Hot Mobile and Golan Communications, among others, came charging on the scene thanks to policy change in the Israeli government.  The market got flooded with competition.  The extremely competitive pricing from the new boys left investors worried.  Surely, CEL would not be able to keep the dividends up and growing.

Well, that's exactly what happened (and don't call me Shirley).  Dividends were reduced for 6 straight quarters.  Stock prices fell (which ironically lifted the dividend percentage to where it currently sit at over 20%, but I digress...).  It seemed that the old dog had no new tricks to play this new kind of ball.

A Glimmer on the Horizon

A couple of months ago, Cellcom announced its new plan: Cellcom Total.  Cellcom total "combines an unlimited package of three cellular subscribers plus internet and landline services." And all for one-low price.  Cellcom was the first of the established players to make a big change in bundles and pricing.  This initially caused a small rally, which fizzled out.

But now that we have the quarterly results, it would seem as though things are working.

  • Total revenue from services up 4.5%
  • Free cash flow up 63%
  • Completed merger with Netvision
  • They beat the street by a penny per share

Investors are loving this news.  Like I said, the stock was up as much as 16% last week.  It also seems pretty reasonable.  The company's valuation was hovering around a P/E ratio of 4.  The report was good.  The whole package just makes investor's mouths water.

But...

Hold your camels, before you go throwing you life savings into this stock.  Here's the other half of this story.  

  • Operating profit down 29%
  • Net income down 50%

It is on this last point that I would like to stop and ponder.  Net income is half of what is was last year.  I would venture to guess that their new competitive prices have a lot to do with this.  It only makes sense that if you have to lower prices to stay relevant, then your bottom line would take a hit.  Granted, they could afford to take a margin hit, and still remain profitable.  They've been paying out huge dividends for years with their surplus.  But if their margin shrinks, then that leaves less room for the dividend, the very reason a lot of us would get in in the first place.

In fact, that is what exactly what Cellcom Israel has decided to do: suspend their dividend for the time being, after having raised the dividend in the last quarter. I believe that raising the dividend last quarter was just a desperate move to lure investors back in. If a 50% net income loss is a sign of things to come, who knows if and when they will ever be able to reinstate it. If they do reinstate the dividend next quarter, we investors will need to be sure that the net income is starting to get better. Cellcom is showing that they can adapt to stay in business, but they don't have the profit margin that they used to. It seems that they would like to call investors back, but I think we may need to hang up.


thequast owns shares of Cellcom Israel. The Motley Fool has no positions in the stocks mentioned above. 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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