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Small Telecom, Big Dividends
03/02/2011 1:09 pm EST
Israel’s leading wireless carrier boasts a double-digit yield and an excellent long-term track record, writes Jon Markman, editor of Trader’s Advantage.
Cellcom Israel (NYSE:CEL) is Israel’s largest wireless telecommunications company. It should be particularly attractive to income-oriented investors, as the foreign carrier pays a hefty 11.4% dividend and has generated consistent cash flow for years.
Also, it’s been beaten up a bit on the developments in Egypt, which ought to subside and lead to a rebound.
Since going public in 2007, the company has outclassed its American counterparts in the hearts of investors. Due largely to its faster growth rate—17% per year—shares in CEL have risen 160%, as shown below.
Despite this big run, it is still cheap, trading at nine times trailing 12-month earnings—that’s a nice combination.
Cellcom has 3.3 million customers and 34% of the Israeli telecom market. Its largest competitors, Partner Communications (Nasdaq: PTNR) and Pelephone, control 32% and 29%, respectively.
More Cell Phones than People
Israel now boasts one of the highest levels of mobile penetration, with 127.5 phones per 100 inhabitants. Further revenue growth will come from increasing value-added services, such as access to mobile Internet, ringtones, text messaging, mobile wallets and video games.
Year-over-year subscriber growth was moderate at 3.6% in 2010, but high-speed subscribers increased 18.4% to 1.1 million. Revenue from data and text messaging jumped 24.9%. With only one-third of its customer base using smartphones, Cellcom has plenty of room to increase revenue from voice-only customers.
While Cellcom is not a dashing new technology company, the carrier is an extraordinary cash-flow machine. It boasts 40% gross margins and the firm’s operating margin increased three percentage points compared to last year. Free cash flow jumped 13% while earnings rose 9.3% year-over-year.
Its borrowings—$1.2 billion in debt vs. $320 million in cash and equivalents—are hefty, but shouldn’t be problematic because of that ample cash flow. Earnings covered interest expense 6.8 times over. Getting away from all the mumbo-jumbo, all of this just means the company is in good financial health.
CEO Amos Shapira has done an impressive job of creating value for shareholders. Dividends have grown 39% in the past three years to $3.58 a share, and profitability increased during the global recession.
Next: Competition on the Rise|pagebreak|
Competition on the Rise
Israeli regulators have created a very competitive business environment for carriers that has slowed revenue growth. Subscribers can switch carriers without losing their original number, which has reduced Cellcom’s pricing power.
Analysts expect Cellcom to earn $3.01 in 2011, which is actually 9% lower than 2010 fiscal year estimates. This peculiar situation reflects recent regulatory changes—but also provides us with an excellent opportunity.
Downside risk has already been factored in the price, and there is a lot of upside if the carrier beats estimates, which CEL has done by an average of 11% over the past five quarters.
It’s impossible to talk about investing in Israel without considering the political risk. Instability in the region could turn a pro-Western dictatorship into anti-Israeli democracy that threatens earnings potential in companies like CEL. I don’t think the turmoil will destabilize the region, but it is one factor keeping the price of the shares down in the past month.
Top-line growth will remain mild, but as subscribers demand high-quality broadband service to access the mobile internet, Cellcom Israel’s profits will increase.
I expect the firm to beat estimates and lift earnings to at least $3.40 a share in 2011. Applying a price/earnings multiple of 12, we’re looking at the potential for a $41 stock. [Shares closed a bit above $30 Tuesday. In November, Carla Pasternak profiled a Thai wireless carrier with a similarly generous dividend.—Editor]
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