Spanish telecom giant Telefonica S. A. (TEF) is expected to deliver strong profits throughout the year by leveraging cost-cutting initiatives, restructuring efforts and the benefits of Telefonica Global Resources. The company aims to enhance overall revenue this year with continued focus on fixed and mobile broadband growth as well as strong commercial activity.
Effective January 1, 2012, Telefonica has restructured its operations into two regions –– Europe and Latin America –– and two global business units –– Telefonica Digital and Telefonica Global Resources. Operations in Spain will be included in Europe.
We believe that restructuring increases the prospects of Telefonica and provides it with greater opportunity to outperform in the global digital market, be more efficient as well as generate economies of scale for growth and innovation in its international businesses.
Regionally, Latin America remains one of the best performing regions for Telefonica, especially Brazil. Telefonica Europe continues to gain market share from increasing smartphone penetration and data growth.
Coming to Spain, the business is exposed to higher churn rates (customer switch) and the ongoing reduction in mobile termination rates (MTRs), which is the fee that operators charge each other to connect calls. Further, the economic downturn in that country has been more than expected and is likely to drag the company’s profits and liquidity.
Due to weak Spanish operations, the company reported lackluster earnings in the first quarter that were below the Zacks Consensus Estimate and the year-ago quarter.
However, the company is making various efforts to turn around its Spanish operations, which are expected to be profitable by the next year. Telefonica would realize substantial savings from the job cuts over a three-year (2011–2013) period. Further, the strength is expected from competitive and higher quality service offerings as well as reduced churn. Further, restructuring of the financial sector and sustainable debt will bode well for the future growth of the Spanish business.
Despite the layoff plan, assets sales and debt cuts, Telefonica’s earnings prospects remain gloomy due to its highly leveraged balance sheet. The company currently operates with a high debt level. Additionally, Telefonica is funding its acquisition activities by raising debt, thereby resulting in higher interest expense. Moreover, the ongoing initiatives to improve efficiency and enhance mobile data across regions will increase commercial expenditure, and result in earnings dilution.
Further, Telefonica remains challenged by a weak domestic economy, the slowdown in Brazil, the ongoing reduction in mobile termination rates, a highly leveraged balance sheet and growing competition from France Telecom S.A. (FTE), Vodafone Group Plc (VOD), China Mobile Ltd. (CHL) and America Movil S.A.B. de C.V. (AMX).
Hence, we are maintaining our long-term Neutral rating on Telefonica. But for the short term (1–3 months), the stock retains a Zacks #4 (Sell) Rank.
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