The European telecom sector has been under pressure for a long time. High capex needs combined with the long European recession (which produced price wars across the region) have made margins tumble. That said, most European telecom companies have profitable investments made in high growth Emerging Markets (EM), above all in Latin America. Let’s take a look at the first quarter results of two of the main European telecom enterprises and try to see whether they represent a buying opportunity or not.
Telefonica: Brazil is now its biggest market.
Telefonica S.A. (ADR) (NYSE:TEF)‘s main market is, for the first time, outside the European continent. The company revealed that revenues from its Brazilian branch outgrew those coming from Spain. Actually, Latin American sales (Telefonica has businesses all across the continent, from Mexico to Argentina) accounted for more than 50% of the group’s total top-line.
Operations in Brazil became the company’s largest not only because Brazil is growing but also because Spain is shrinking fast. Revenues in Spain fell 18% Year over Year (YoY), well beyond my expectations. Besides, the whole European continent under-performed: revenues declined in the UK, Germany, Ireland and the Czech Republic.
Overall, revenues fell 9% YoY and the group’s operating income dropped 18%, while net profits surged by 21% YoY (last year Telefonica S.A. (ADR) (NYSE:TEF) wrote-off aggressively its Italian investments).
Taking into account all of the above, and with Spanish mobile tariffs still falling as I write this article,Telefonica Brasil mobile (Vivo) should keep on growing fast, boosted by accelerating smartphone adoption and less tariff competition than a year ago. Besides, Mexico should continue to accelerate as it benefits from a better competitive environment.
Telecom Italia looks cheap.
Over last month, the shares of Telecom Italia S.p.A. (ADR) (NYSE:TI), which is 10.5% owned by Telefonica S.A. (ADR) (NYSE:TEF), went up by almost 7%. That said, I still think the company looks cheap.
Telecom Italia S.p.A. (ADR) (NYSE:TI) trades at an adjusted 2013 equity FCF yield of 20%, 2013 3.5x EV/EBITDA and 5.8x P/E. This valuation represents a steep discount to its peer group. Besides, even if the European (and Italian) telecom market is performing (very) poorly, the company has an interesting presence in Latin America (through subsidiaries such as Telecom Argentina S.A. (ADR) (NYSE:TEO)).
Without discussing the possibilities around mergers (with 3Italia, for example), Telecom Italia S.p.A. (ADR) (NYSE:TI) looks like a compelling investment at current prices. To set an example, France Telecom SA (ADR) (NYSE:FTE), which does not have relevant investments within Latin America but does have a sizable presence in Africa and Asia, trades at an adjusted 2013 equity FCF yield of 15%. Even if France Telecom SA (ADR) (NYSE:FTE) also looks relatively cheap at a 15% FCF yield, the company trades at 2013 4.5x EV/EBITDA, which is a 1x EBITDA premium to Telecom Italia S.p.A. (ADR) (NYSE:TI).
Bottom Line
Overall the European telecom sector is offering many opportunities ahead, but you should be careful when going long. I made a mistake when i bought Telefonica S.A. (ADR) (NYSE:TEF). Even if it could be a great time to buy for the long term, the company is facing an incredibly tough time in its home market (Spain). I do not expect the shares to strongly out-perform the market until the dividend is re-instated. Telecom Italia S.p.A. (ADR) (NYSE:TI) looks awfully cheap at current prices, but you should be careful if you go long; a tough reality could easily become tougher (as it happened in Telefonica’s case). My recommendation: have these companies in your watch list but don’t go long just yet.
The article Results Recap: Eropean Telecom Companies originally appeared on Fool.com and is written by Federico Zaldua.
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