Collect Call to Brazil

06/09/2010 11:48 am EST

Focus: GLOBAL

Carla Pasternak

Editor, The Income Investor

Brazilian telecom giant Tele Norte Leste is far too cheap given the dividends it throws off, writes Carla Pasternak in High-Yield International.

Known as Oi, Tele Norte Leste Participacoes (NYSE: TNE) is the largest telecom operator in Brazil. Oi operates about 22 million fixed lines and has about 34 million wireless customers in the country.

The company usually pays several dividends per year, but the amount and timing of the payments vary. Oi paid $1.60 ($1.17 dividend plus a $0.43 interest on capital payment that went ex-dividend in 2008) in November 2009 and has declared a dividend of $1.66 that went ex on April 19th. That amounts to payments of $2.83 over the last year for an astounding yield of 18%. 

The share price has fallen over 30% so far this year and about 20% since mid April. True, the Standard & Poor’s 500 index has been down recently as well, but not nearly as much as TNE. What's going on?

There doesn't appear to be any fundamental reason for the fall. First-quarter results were solid. While year-over-year net revenue was roughly flat, earnings before interest, taxes, depreciation, and amortization (EBITDA) rose 6.5% from the [same quarter a year ago] to 2.5 billion reais ($1.4 billion). The integration of Brazil Telecom resulted in cost synergies, and operating expenses fell 7% for the quarter. 

The loss of fixed-line subscribers is being well compensated for [by] growth in mobile. Wireless subscribers grew 15% year over year in the first quarter. Revenue generating units (RGU) companywide—considered any subscriber to any service—increased 8% in the past year to 62.2 million total customers. Plus, EBITDA per RGU rose 7%. In other words, the company is making more profit per customer and adding customers at the same time.

The one worry I have is with the extra debt load taken on to acquire Brazil Telecom. Now, the company carries net debt of more than $13 billion, with a bond worth about $1.5 billion coming due in 2011. That said, EBITDA in the last quarter of $1.4 billion easily covered interest expense of $366 million.

A likely reason for the fall in price, however, is shorter-term market dynamics. [Like] Brazilian stocks, TNE outperformed the S&P 500 last year, returning 83.7% in 2009, and is underperforming this year.

[Also,] in May, the US dollar gained more than 6% against the Brazilian real as fear in the market caused investors to turn towards the relative safety of the dollar. A strengthening dollar lowers TNE's dividends in dollar terms. 

Defensive and high-yielding telecom stocks—especially those in emerging markets like TNE—could be the market's darlings [in the future] as many predict slower economic growth in developed economies. The recent weakness in TNE creates an entry point for longer-term investors, although I plan to watch its debt closely. That said, it's also comforting that the company carries more than $4.6 billion in cash on hand.

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