Two safe haven stocks from the telecoms sector

At a 31% to the MSCI World benchmark, telecoms stocks are some of the cheapest around. However, low prices belie the recovery the sector has made over the past two years - and the steady stream of cash phone stocks are set to deliver in the future.

The turmoil of the past six months has sent global stocks to their lowest valuations in more than 30 years, on some measures. Cheapest of all, says Bloomberg, trading at a 31% discount to the MSCI World benchmark, are telecoms stocks.

But these low prices belie the recovery telecoms have made over the last two years. They also discount the steady stream of cash that phone stocks are expected to deliver in the future.

In fact, the telecoms sector looks the ideal safe haven amid the subprime blowout. As Vittorio Fegitz of RBC Asset Management tells the National Post, "it has taken European telecoms seven years just to repair their balance sheets following the expansion excesses which came to a head in 2000".

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The hangover from the tech blow-out ensured that telecoms have played no part in the debt binge that has fuelled markets in recent years. So, light on debt and with a few years of successful consolidation under their belt, telecoms are looking lean and battle-hardened.

The traditional fixed-line phone business might be showing its age, but expanding into the mobile phone and broadband sectors has breathed new life into telecoms. The prospects for growth in these businesses might be withering now that two in three houses in the UK has a broadband connection, but telecoms have discovered a rich revenue stream by cross-breeding the two. Big things are expected of "Triple-play", which offers phone, broadband and TV in one system for your home. But meanwhile, revenues from offering "mobile data" sending texts and selling ringtones are growing by 30%-40% a year among European telecoms and will continue to do so in the years ahead, says Citigroup.

Beyond Europe, growth prospects for mobile phones in emerging markets are huge. In the absence of old-fashioned landline infrastructure, Brazilians and Indians have been as quick to adopt new technologies as the more mature markets in Europe. In fact, emerging markets that have been using fixed-line phones are switching to mobiles anyway. In November alone, China added nearly eight million mobile subscribers, while losing 1.3 million fixed-line users, says Tero Kuittinen on Since 2001, emerging markets have added 660 million new mobile subscribers, says UK telecoms watchdog Ofcom, accounting for 40% of new mobile accounts globally.

But there's a long way to go we might all have a mobile in the UK, but only 50% of Brazilians have mobiles, and China (34%) and India (14%) are especially ripe for growth. Vodafone, which took a big step into the Indian mobile market earlier this year with the takeover of local mobile operator Hutch Essar, thinks that over 40% of India's population will have one by 2012. As these markets mature, mobile users in Latin America and Asia will no doubt discover the same fascination with mobile data and "playful" ringtones that we unaccountably enjoy here in the UK. In China, where cheap texts trump voice calls, the mobile content market is already thought to be worth $10bn.

Growth prospects aside, what telecoms offer is a steady cash-flow stream good news at a time when debt is much harder to come by. Safest of all are large-caps in the sector, says Citigroup preferably with emerging-market exposure. European telecoms (see box below), with little or no exposure to the plunging dollar, look the best bet.

The two best bets in the telecoms sector

One large cap that has plenty of exposure to emerging markets is Telefonica SA (NYSE:TEF). The Spanish giant is the world's largest mobile-phone operator and provides telecom services to Europe, Africa and Latin America, where it has a dominant market position.

Will Frankenhoff of Motley Fool describes the stock as a "growing bond" the company's solid European business supplies the bond component, while growth prospects in wireless and mobile telephony in Latin America offer earnings growth. Telefonica is expected to produce earnings per share growth of 23% in 2008 and 14% in 2009, according to RBC's Fegitz. And with a price-to-earnings-growth ratio of 0.5 for 2009, you're getting that earnings growth pretty cheaply. It trades on a forward p/e of 8.4 for 2009, according to Digital Look, offering a very attractive dividend yield of 5.2%.

Closer to home, Citigroup analysts like the look of mobile giant Vodafone (VOD). The company is restructuring at the moment, but its recent moves into Turkey, and particularly India, distinguishes it among the emerging-market plays. Growth in cash profits is expected to top 30% a year in the next five years. Vodafone is valued on a forward p/e of 13.3 for 2010, and pays a 4.6% dividend yield.

Eoin came to Money Week in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.

Eoin acts as managing editor of MoneyWeek's newsletters.