Share tips: There’s life left in mobile

With investors turning their backs on Spain, Spanish stocks could be the contrarian trade of the decade, says Paul Hill. And this Spanish telecoms giant is a great place to start.

Right now, one market everyone hates is Spain. But if European Central Bank boss Mario Draghi can bring down borrowing costs for European governments, this could be one of the contrarian trades of the decade. Falling yields are very helpful for Spanish companies with stretched balance sheets, like telecommunications giant Telefnica (owner of O2). At last count it had a net €58.3bn of borrowings (equivalent to 2.7 times EBITDA) with a blended interest rate of 5.5%.

In July, it suspended its dividend, a measure not taken since the 1930s civil war. Director salaries were hacked by 20%-30%, and a series of asset sales started. A 4.6% stake in China Unicom went for €1.1bn in June. Preparations are also underway for the partial flotation of its German unit. Non-core assets such as Atento, its call-centre business, are likely to be chopped too.

But as the launch of the iPhone5 testifies, there's a lot of life left in mobile, especially in emerging markets such as Latin America (50% of profits): Telefnica is the lead operator in Argentina, Brazil, Chile and Peru. Even in Britain, Germany and Spain, cashflows are predictably solid, as most of the group's network build-outs are complete. Yes, 4G spectrum is being sold off in the UK, but this outlay should be more than offset by the annuity-type returns of its 312-million customer base.

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Telefnica (Madrid: TEF), rated a BUY by AlphaValue

608_P11_Telefonica

The one weeping wound, accounting for 32% of profits, is the domestic market. Telefnica is suffering as an already weak economy gets even worse. But management is cutting costs and slashing subsidies for handsets across the board. With overseas units ticking along nicely, it shouldn't take much of a rebound in Spain to boost the stock. For 2012, analysts expect €21.4bn of EBITDA on turnover of €62.7bn, with net debt falling to a manageable 2.4 times by December.

There is execution risk around the debt-cutting plan. The industry is also being hit by fierce competition, falling termination fees and deregulation. There's also Argentina to worry about not content with seizing a controlling stake in YPF from Repsol (the Spanish energy group), the government recently fined Telefnica for failing to prevent a wireless outage.

But the company is adamant none of this will affect the €0.75 dividend planned for 2013 (forward yield of 6.4%). AlphaValue has a €17.20 price target. Third-quarter results are scheduled for 7 November.

Rating: BUY at €11.20 (market cap €52bn)

Paul writes the Precision Guided Investments newsletter. See moneyweek.com/PGI or call 020-7633 3634.

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Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.