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Telefonica: Still A Good Buy After Dividend Cut

The yield is over 12%. The red flag? That's for the capital markets

   

Telefonica (NYSE:TEF), one of my favorite stocks for years, is down around 24% over the past year and around 4% already in 2012. Although I’ve still made gains on TEF, after recommending it in June of 2010, the dramatic reversal of this stock has been frustrating, to say the least.

Telefonica made headlines by slashing its enormous dividend just months after management announced that there would be no cuts. It appears the market had been anticipating a cut — the stock fell prior to the announcement and barely moved after.

Normally, red flags are raised when a company slashes its dividend because, like cockroaches, there is rarely “just one” dividend cut. Raising a dividend sends a powerful message: The company is healthy, and the future looks bright enough to justify parting with some of its cash on hand. A reduction in one’s dividend sends precisely the opposite message: that things are bad and not getting better anytime soon. And, again, dividend cuts often beget more dividend cuts.

Still, we have to take Telefonica’s cut in context. The move reflects not so much a negative view of the company’s prospects as a negative view of the capital markets.

Telefonica has large investment requirements in the years ahead. Normally, the company would just borrow the money it needs. Its projects enjoy a high enough return on investment and produce stable enough cash flows to justify a high level of debt financing. Alas, these are not normal times. Management sees the volatility roiling the capital markets and can read the writing on the wall for Europe’s banks. They do not want to be in the uncomfortable position of needing to borrow when banks are deleveraging and are not particularly interested in lending. And when your home country has serious debt issues of its own, the bond markets may not be the friendliest place for Spanish companies in 2012.

Management is doing what it feels is prudent. It is reducing its dividend to retain a little extra cash.

So, given this, do I still consider Telefonica to be attractive? Absolutely.

Even after the cut, Telef0nica yields over 12%. And its growth in Latin America, which already accounts for 40% of revenues, is stronger than ever. I originally recommended Telefonica because it was an emerging-market growth stock masquerading as a Spanish stock trading at crisis prices. Also, Telefonica trades for 14 times earnings, which is around the U.S. average.

Barring a full-blown European meltdown, this stock could easily see total returns of 50% to 100% in the next 12 to 18 months. Telefonica remains one of my favorite picks for 2012 and beyond.


Article printed from InvestorPlace Media, http://investorplace.com/2012/01/telefonica-good-buy-despite-dividend-cut/.

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