Buy, Sell, or Hold: Telefonica


When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at Telefonica (NYS: TEF) today, and see why you might want to buy, sell, or hold it.

With a market capitalization near $55 billion, this Spain-based telecommunications giant has seen its stock swoon by around a third over the past year.

One of the first things you might have noticed about Telefonica up to a week or so ago is its dividend -- which recently yielded 11.1%! I'm sorry to report that it's actually being suspended until late next year, but this is actually a good thing, as it will bolster the company's financial health.

The company's line of business is also attractive. Consumers might cut back on some goods and services in tough times, but most will want to keep their phone service and telecommunication abilities. Indeed, smartphones and other telecom-based devices are proliferating at a rapid clip.

Telefonica's financial statements are generally appealing, too. It's true that free cash flow has been slipping some in the recent tough environment, but it's still substantial, with close to 7 billion euros generated over the past year. Operating cash flow in particular has held up rather well, as has revenue. (Net income, though, has been sliding.) While it's common to see a company's number of shares outstanding rise over time, Telefonica's share count has actually been inching down, so share dilution is not a worry here at this point.

Looking for an attractive valuation? Well, the company's price-to-earnings ratio is around 10, which is roughly on par with its five-year average. Its price-to-book, price-to-sales, and price-to-cash-flow ratios, though, are all considerably below its five-year average, and below industry averages, as well. Its forward P/E ratio is below 6, and its P/E-to-growth ratio was recently a mere 0.30. (A number below 1.0 suggests an investment might be undervalued.)

Despite all of the fetching aspects of Telefonica, it does have some red flags. For starters, remember where it's headquartered: Spain. About 25% of its business comes from that economically beleaguered nation, and things might get worse for Spain before getting better. It's not the only telecom giant experiencing European-economy pains. France Telecom (NYS: FTE) , with its own hefty dividend yield of about 12%, is down 14% over the past year. And it's not the only Spain-based giant getting whacked, either. Banco Bilbao Vizcaya Argentaria (NYS: BBVA) , for example, is down some 17%, while Banco Santander (NYS: SAN) is off 18%. These companies' considerable non-Spain operations are propping up shares to some degree -- as is the case with Telefonica as well. About 70% of its operating income in 2011 was generated elsewhere in Europe and in Latin America - such as in fast-growing Brazil.

One red flag on the company's financial statements is its debt level, which is very steep at $84 billion (about 2.6 times equity) recently and has been rising.

Then there are capital expenditures. Telefonica spent north of $10 billion on capital expenditures in 2011. Less capital-intensive businesses can be more attractive, but you can also view these expenses as a good thing, as the company was investing in its future, expanding into Latin America and making big spectrum buys in Spain to spur growth.

Hold (off)
Given the reasons to buy or sell Telefonica, it's not unreasonable to decide to just hold off. You might want to wait for Spain to get in better shape, or for Telefonica to start reporting rising earnings -- or, better still, for the company to significantly reduce its debt burden.

You might also take a look at its competitors, such as Latin American rival America Movil (NYS: AMX) . Its P/E ratio is only slightly below its five-year average, and its dividend yield is puny at 0.6% (though that beats Telefonica's current zero). But its subscribership is growing and it's moving into 4G services, too, which bodes well. It's growing in the U.S., too, with its pay-as-you-go TracFone.

The verdict
I'm personally holding off on Telefonica for now but, overall, it has a lot to recommend it and it may well perform spectacularly in the coming years. Still, there are plenty of compelling stocks out there. Everyone's investment calculations are different, though, so do your own digging and see what you think.

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Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of France Telecom, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. The Motley Fool owns shares of France Telecom. Motley Fool newsletter services have recommended buying shares of France Telecom. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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