Investing in the IBEX 35 — Telefónica
Introduction to the firm
Telefónica is a Spanish €21bn telecommunications group operating in Europe and Latin America trading at €4,1 per share. The firm is present in 14 countries (operations in Costa Rica and Salvador yet to be sold) and has 114k employees. In the last 12 months, the company’s top line (revenue) was of €48.5bn euros and its bottom line (net income) was of €341million, giving it a 0.7% profit margin. As of January 2020, the company had a total of 344 million APs (access points) worldwide. Telefonica’s brands include Telefonica, Movistar, Vivo and O2.
Telefónica’s offering includes Mobile business, Fixed-line telephony and Digital services. Its market segments include Telefonica Spain, Telefonica Brazil, Telefonica Germany, Telefonica United Kingdom (O2) and Telefonica Hispanoamérica (formed by operators in Argentina, Chile, Peru, Colombia, Mexico, Venezuela, Ecuador and Uruguay).
Despite the Spanish (Accesos = APs, Ingresos = Revenues, Reino Unido = UK), the image below shows the % of Total Revenue from each of the firm’s market segments, with Spain, Brazil, Germany and UK, the firm’s 4 core markets, composing 77% of total revenues.
The company’s appeal to investors comes from its diversified portfolio of operations, its high dividend yield currently above 9% and willingness to invest in one of Europe’s strongest positioned TELCOs. Nonetheless, several factors are responsible for dragging the stock down from its 07 highs of €33. The firm has amassed the greatest amount of LT debt amongst Ibex 35 companies, standing at slightly over €38bn. Furthermore, it has seen some HISPAM operations become unproductive or unprofitable, having to sell them to focus on core markets. Additionally, it’s UK O2 operations have lacked direction up until now, where a merger with Liberty Global’s Virgin Media will create the second largest fixed + mobile telco in the country behind BT with a £31.4bnvaluation, re-position the business and exploit cost synergies of about half a billion pounds.
This leads me to the point that Telefónica is undergoing a large scale strategic restructuring process under CEO José María Álvarez-Pallete.
The merger plans to reduce its heavy debt by more than €6bn thanks to the cash it expects to receive from the transaction. Furthermore, in the last decade, the firm has trimmed down its debt by €17bn. Other actions like the hiring of consulting firm Kearney to rejig its Telefonica International Wholesale Services (TIWS) group indicate the firm is actively looking to improve its positioning and fiscal discipline for a highly competitive industry with razor thin margins.
Financial Performance
Now I’m going to look at some key financial ratios regarding different aspects of the business in order to put into perspective its leverage and prospects of growth and profitability.
While its FCF has varied across years, it’s important to note it has been increasing over the last 5. Having a growing amount of money free of commitments to purchase stock back, pay dividends, repay debt or reinvest in the business is a good sign.
Financial Health:
- The firm’s D/E ratio is of 2.74 and has stood above 2 the entire last decade. Whilst a certain amount of leverage might be beneficial for tax purposes and to not dilute existing shareholders, keeping this number under 2 would be the best option for Telefónica to not feel the brunt of its debt pile.
- Similarly, its current ratio, or ability to pay short-term obligations, has improved from 0.63 to 0.81 from 2010 to 2019 respectively. Nonetheless, having it above 1 would put the company in a more favourable position.
- On the bright side, Telefonica’s average CapEx as a % of sales in the last decade has been of 16.8%. This figure stood at a solid 15.8% in 2019.
Valuation: Telefonica currently trades at a P/E ratio of 7.56. The industry’s average of 12 and the firm’s average of 16.4 in the last decade can indicate the company looks attractive in comparison to its peers. However, we shouldn’t only rely on this metric to purchase the stock.
Dividend: The firm has indicated that it has the debt maturities of the next two years covered with a liquidity position of 22.5bn euros, of which 8.7bn correspond to available liquid assets. The company has clearly struggled to keep a constant dividend. In fact, it has reduced it by 6% from last year to this one, where it will pay 0.4 euros per share. It’s also important to keep in mind the firm offers to pay a scrip dividend (in the form of shares) voluntarily in order to preserve cash. Investors should be careful the firm can pay down its debt as it distributes its dividend. Thankfully, the nature of the business will allow it to generally perform well during Covid19 as demand for broadband and digital services rises.
Key considerations going forward
- Competitors include Vodafone and BT (UK), Deutsche telecom (Germany), MásMovil and Orange (Spain) — crowded market space with downwards price pressure to reduce churn rates and attract consumers
- Telefonica’s digital services arm grew 17.1% in 2019 to €7.7bn in revenue. This includes video, cloud, security and IoT , service lines in growth phase that if exploited well, could turn out to be a significant piece of the firm’s revenue pie.
- Industry trends like the surge of 5G, consolidation among big players and building an omni-channel enterprise geared to the comfort of the consumer are some of the challenges these big TELCO players will have to deal with going forward.
In essence, Telefónica is committed to a turnaround and strong industry positioning in EU and LATAM through its M&A activity, reduction of debt and reorganization of the businesses core assets and markets. The resolution of Covid-19 in 2020 with the turnaround story successfully on its way could be reasons to believe in the stock. The intense competitive rivalry, variable dividends and big debt pile are factors that might make investors reluctant to purchase at this point. Overall, I’ll be closely watching the strategic moves of this company and assessing an entry point when Covid19, the UK merger and its debt pile have all advanced in positive directions.
