Telefonica Weakness Foretells Bargain Entry Point

 

• Company Benefiting From Asset Sales and Acquisitions
• Strong Shareholder Value Via Buybacks and Dividends
• Technical Analysis Signaling Better Entry Points Ahead

Telefonica S.A. (TEF:SM) is a diversified telecommunications provider operating across Europe and Latin America providing mobile, fixed-line, internet, and data services to individuals and businesses.  The company is the largest telecom operator in Spain and has a presence that stretches across Central and South America in conjunction with European operations that extend past the Spanish border.  Shares have largely managed to outperform the benchmark Spanish IBEX 35 of which Telefonica is a component, however, the outlook is challenging considering the geographical dependencies of the company as it tries to focus on growing revenues both organically and through acquisitions.

The Fundamental Perspective

Telefonica has been able to benefit from the recent acceleration in its home market Spain while high growth Latin America exposure helps the company to prepare to deliver longer-term value to shareholders.  The company itself has a strong history in Spain and across Europe with several holdings that focus outside the core geographical interests.  The latest numbers however show that the company is facing difficulties, falling short of analyst predictions as evidenced by the gap down in shares following the latest earnings revelation.  Even though revenues grew 13% versus the prior year, the EUR 11.54 billion recorded missed estimates of EUR 11.74 billion.  Net income grew substantially owing to tax benefits from the O2 asset sales, but the company does face headwinds as revenue in Spain lags behind.

Looking at the balance sheet, the company exhibits very high levels of debt considering its market capitalization of EUR 64 billion.  However, the sale of O2 mobile service in UK to Hutchinson for GBP 10.25 billion has helped bolster the outlook and moreover enabled the company to work towards targets of cutting debt by over 30%.  Telefonica has a strong focus on growth through acquisition as evidenced by the purchase of German competitor E-Plus for EUR 12 billion back in 2014 which is helping maintain revenues at a time when the Spanish core market is faltering and seeing contraction.  The recent acceleration in Spanish GDP growth to the fastest pace in years seems optimistic in the eyes of investors, but overlooks the obvious factors preventing growth such as startling high unemployment which tops of 25%. 

For investors appreciative of shareholder value, Telefonica is a one-stop shop at the moment.  The company’s strengthening revenues, exemplary record of returning cash to shareholders, and stock buybacks are creating the perfect conditions for a sharp rise higher in valuation, especially considering the price-to-earnings ratio of 14.6 is not unreasonably high for a telecom company that operates in many high growth Central and South American marketplaces.  Dividends have also been notably strong, with the latest payout of EUR 0.40 putting the yield at just over 6%.  Shares have not reflected this future optimism or income, owing to cratering growth in emerging markets as foreign direct investment flees these economies. 

The Technical Take

From a longer-term perspective, Telefonica has seen share prices gradually improve over time, recently hitting highs in March last seen in 2011.  The shares have been trending higher in an equidistant channel formation which traditionally offers a bullish bias.  Telefonica recently hit the top of the channel after strengthening ahead of earnings, only to fall after revenues printed below expectations despite the gains on the bottom line.  However, from that point of view, the trade at the moment is to wait for a substantial dip in prices towards the lower channel line which offers a much more promising entry point for a long position, not to mention a better value and higher dividend yield.  With the confluence of European quantitative easing forecast to boost the near-term outlook for prices and misguidedness in fighting the actions of the Central Bank, short positions in an upward trending equidistant channel are unwise.  Following the trend provides better reward potential whereas fighting the trend sees reward diminished and risks rise. 

On a medium-term basis, shares have been stuck in a horizontal range since gapping higher on January 23.  The sideways trend between support at EUR 12.85 and EUR 13.96 is fairly narrow, reflecting the commonly held view that stocks spend the majority of their time trading horizontally with fundamental events accounting for shifts in momentum higher or lower.  From a strategy perspective, the ideal way to handle the situation is long positions from the major support level targeting resistance where positions would be generally flipped short, targeting support.  However, with no major upcoming news developments forecast especially after the latest most recent earnings call, there is a strong possibility that Telefonica shares will be driven higher by flow trading alone as the Central Bank’s monetary policies stoke asset valuations.  Risks in the short-term are acutely to the downside as evidenced by the sentiment towards shares following the gap down in prices after the earnings announcement.  Nevertheless, the company’s core services are becoming more necessities than wants in the modern world and could provide a great entry point for investors seeking to add to long-term holdings.

Conclusion

Telefonica is struggling from near-term headwinds from a faltering global economy even though the European Central Bank’s quantitative easing program should broadly benefit European stocks and assets.  The technical while pointing to a longer-term uptrend show that near-term long positions are not suggested at current prices due to Telefonica shares trending near the top of the channel and presently stuck in a horizontal range.  However, broad and diversified geographical exposure coupled with a strong dividend and strengthening balance sheet could make Telefonica a great longer-term buy for investors with the right timing even if the bias is towards the downside in the short-term.