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Dump the Phone Maker for the Provider

04/19/2012 8:30 am EST


Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Telecom can be a risky business, whether you’re running a company or simply investing in it. Below is a company that has handled risk successfully for decades, whether in an underdeveloped Latin America or a shaky Europe, observes Mark Skousen of High Income Alert.

We hit our sell stop on Nokia (NOK) last week, after the handset maker lowered its first-quarter guidance.

My suggestion? Take the proceeds and put them to work in a stock we’ve traded profitably before: Telefonica (TEF). Based in Madrid, Telefonica is a world telecom leader, offering landlines, cell phones and services, network leasing, cable and satellite television, and broadband services.

With Spain’s unemployment rate at 23% and the country’s bond market under pressure right now, you might wonder why anyone would invest there now. But this is how contrarian opportunities are born. Let me explain…

Telefonica isn’t just a Spanish phone company. It has more than 280 million customers in 25 countries, with a particular emphasis on Latin America. Unlike the United States, Europe, and Japan, GDP growth in most Latin American countries is perking up nicely. And TEF also is expanding rapidly in Asia in a partnership with China Unicom.

Despite the well publicized structural problems in the Eurozone, Telefonica is financially strong. The most recent quarter’s earnings doubled on a 24% increase in revenue. Operating margins top 18%. And management is earning a sizable 21% return on equity.

This is a solid company with a predictable cash flow. Better still, the stock currently is yielding a whopping 11.4%. Could the dividend be cut? It’s possible. (Telefonica lowered the dividend by 14% in December.) But the dividend certainly isn’t likely to be eliminated. I estimate that Telefonica will earn $1.80 a share this year and about $2.25 in the year ahead.

The euro, of course, has been under pressure and could weaken further. But that’s not all bad here. A significant amount of Telefonica’s revenue comes from outside the region. So it is insulated somewhat from further euro weakness, and may even reap a windfall on the currency exchange.

Plus, it’s important to understand that the negatives that currently exist in Europe are already discounted. As the old Wall Street saw reminds us: If it’s in the papers, it’s in the price.

With its steady cash flow, huge dividend, and compelling valuation at less than seven times prospective earnings, Telefonica is a risk worth taking.

So pick up Telefonica at the market, and place a protective stop at $11.50. If you prefer to play this one more aggressively, try the September $17.50 calls, which last traded for 15 cents.

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