Thursday, September 29, 2011

Three Telecoms

Telecoms can be a wonderful dividend growth investment. As always, I like to invest in companies that produce products that people need. I can think of few things people need more than communication with one another. Even in recessions and time of distress, people still use their cell phones and home telephones to communicate with one another. In fact, it could be argued that people use them more in times of people want to stay in touch and make sure family and friends are alright. Many things can be trimmed from an average household budget, but a telephone is likely one of the last things to go. Even if you're unemployed you still need to call potential employers for job openings and you need a way for them to contact you and talk to you.

Of course, the telecommunications industry is not without its drawbacks. Items to consider are relatively high debt due to the need to deploy high amounts of capital to fund new networks and infrastructure. There isn't a lot of room for a high amount of future growth in this industry, especially here in the U.S. I would argue that the players are already out on the field, and there is a fixed amount of population growth here in this country. There is limited potential for high growth as most people already own home phones or cell phones. The potential for growth will likely be less in increasing subscribers and may more likely come from increased sales of costly contracts including data usage for smart phones. Because of this, I'm including only one domestic play and two international stocks so you can have the familiar domestic exposure and the potential growth with international exposure.

Three telecoms that look like solid long-term bets are:

AT&T Inc. (T)

I've written about AT&T many times. I don't own any stock yet, but it's very high on my watch list. It offers an outstanding entry yield at 6%, and has dividend growth as well with 27 years of growing its dividend. Although the dividend growth is slow, with the last raise being just over 2%, you're starting with a pretty high yield which provides current income and fuel for other investments if necessary. I think it's good to have a mix of stocks that provide high entry yield to fuel the portfolio at the beginning, and then have stocks that may have a lower entry yield but higher growth to provide long-term growth. T is a little rocket fuel for a young portfolio, or someone who's older and looking for current income. It also has a fairly low debt/equity ratio of 0.5.

Telefonica S.A. (TEF)

Telefonica trades as an ADR on the NYSE. There are some important factors to consider here. First, it's a foreign company, with headquarters in Madrid, Spain. Because of this you'll have a 19% withholding tax from Spain, and you'll also likely have very small ADR fees passed on to you from some of the major ADR banks. Always do your own diligence. For all this trouble, you'll be getting an entry yield of just over 10%, with a pretty decent dividend growth history behind it. TEF has grown its dividend for 8 years, and has plans to grow it for at least the next 2 years. The stock seems undervalued and depressed currently, fueled by concerns over the weakening Spanish market and the high debt load. Of these concerns, my bigger fear is the debt load TEF carries. It currently sports a high debt/equity ratio of 2.6. This is something to monitor. It's a value play with high debt and a high dividend, so you have to be careful with this one. This is the riskiest of the three, in my opinion.

Vodafone Group PLC (VOD)

Vodafone is currently the second largest wireless phone company in the world behind China Mobile. It has a low debt/equity ratio of 0.4 and a pretty high entry yield of 5.61%. Vodafone is a great way to get international exposure in the telecommunications sector. The nice thing is that although VOD trades as an ADR on the Nasdaq exchange, you won't pay foreign withholding taxes as a U.S. investor due to a tax treaty with the U.K. Vodafone is headquartered in Newbury, England. VOD does not have the dividend growth that the other two stocks listed do, so this would likely be a good complimentary holding to another telecom stock.

Full Disclosure: I'm long TEF.

Thanks for reading.

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  1. I bought a small position in AT&T when I started building my dividend portfolio in order to get my hands on some of that fat yield. Actually got in when it was in the high 5% range. I'm keeping my eye on it; if it drops a couple more points I'll add to the position: a fairly solid 6% yield is hard to ignore!

  2. How about france telecom with over 10% yield and lower debt than telefonica.

  3. currency exchange has become a real concern for European stocks. At the moment the Euro has been slapped down a bit, but a failure in Greece or elsewhere could see a 10-20% loss in your dividends. It's not clear to me how this would affect the valuation of the ADRs.

  4. Dividends For The Long Run,

    Great job in building a small position with T and getting that fat yield. I think T is a great play right now. I'm thinking of initiating a position with T very soon.

  5. Anonymous,

    I've looked at FTE. Seems like a strong pick, and you're right...the debt/equity ratio is much lower than TEF.

    The only thing that would concern me is the dividend going forward. The dividend history is pretty erratic with FTE, but if they can commit to a solid and growing dividend going forward that could be a great play. If I would have included one more telecom play, FTE would have been it.

    They have a strong valuation right now and I think the size gives it some room to grow.

    Are you long FTE? How has it been for you? I know it's been weak YTD as most European ADR's have.

    Thanks for the suggestion!

  6. RobberBaron,

    Excellent point. I think you have a very valid point. This is something I'm watching carefully. A 10% yield is great, but if you lose 15% on a currency exchange and an additional 19% (Spanish withholding* for example), then you're sitting on a lot less cash.

    *I have my TEF investment in a taxable account, so I recoup the dividends withheld when I do my taxes.

    We'll see how the Greece situation plays out. It won't just be ADR's that feel that pain. The markets everywhere will be scrambling and falling. It'll be very scary indeed, but a lot of European stocks will be especially hard hit.


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