Friday, September 14, 2012

Telefonica - Yield? Dig Deeper

With yet another round of firepower launched by the Fed this week, investors will continue to hunt for yield.  In many cases I agree with this approach with the many high quality dividends that are available from some of the largest companies in the world.  However, when searching for yield it is important to make sure that the information you are looking at is accurate.  That brings me to shares of Telefonica (TEF).  Many websites still show this stock trading with a dividend yield.  Check that…..a tremendous dividend yield.  The problem with these sites posting a current dividend yield for TEF, is the fact that TEF is currently not paying a dividend.  In Fact, the dividend was suspended months ago.

I can certainly understand the lure of TEF (especially when being presented with a dividend yield that does not actually exist).  It was hit very hard with the problems in Europe, and especially within the Spain region.  For those of you that do not know, TEF is the incumbent fixed-line and wireless telephone operator in Spain and the Czech Republic. It has the second-most wireless subscribers in the United Kingdom and a big position in Germany. It has substantial fixed-line and wireless assets in Latin America, where 66% of its customers reside. However, they provide only 47% of its revenue and 54% of EBITDA. TEF also owns stakes in Telecom Italia and China Unicom.  I understand the desire to play a European rebound with TEF.  In the AFL Multi-Cap Value Folio I manage, I did just that.  At the close yesterday I decided to take the 16.49% gain after examining TEF’s financials a bit further.

The suspension of the dividend really bothered me as an investor.  When a company generates as much free cash flow as TEF, they should not have a problem paying a dividend.  I looked at the financials a bit further and noticed that TEF may have trouble funding short-term liabilities.  Their current debt-to-equity ratio as of last quarter is 2.62.  It has been well over 2 for several quarters.  A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt, and this can result in volatile earnings as a result of the additional interest expense.  Couple the high debt-to-equity ratio with a very small quick ratio, and it becomes clearer as to why TEF suspended their current dividend.  TEF’s quick ratio has always been below 1 and as of last quarter it was .68.  The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, then the better positioned the company is to meet its short-term debt obligations.  A company with a Quick Ratio of less than 1 cannot currently pay back its current liabilities.

I understand that these numbers vary by industry.  However, when you look at TEF’s unsuccessful attempts to sell assets in Europe, then it does shed more light on the suspension of the dividend.  Consider the following passage from a recent analyst at Morningstar who covers the stock:  While we thought the previously announced continual increases in the dividend to EUR 1.75 per local share were aggressive, to not only stop the increases, but to cut the existing dividend makes us question management's grasp on the firm's ability to generate free cash flow.”  I’m not saying that there is not tremendous value in the shares of TEF.  There may be.  I am simply encouraging investors to not simply search for yield without doing further research.  If you are using sites that have not updated their quotes with the suspension of the dividend, then you may buy a stock simply for the dividend yield, and sadly you will find out there is no dividend.  TEF is obviously worried about short-term liquidity, and as a shareholder you should be as well. 


Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”; Manager/Creator of the AFL Model Portfolios available for members of Allocation For Life in self-directed accounts at Folio Investing