Spanish telecom giant Telefonica (TEF) plans to dismiss 6,500 employees in Spain during 2011–2013. Consequently, the company would incur a total pre-tax charge of €2.7 billion ($3.82 billion) in the current year that will be treated as non-recurring expenses.
Despite these charges, Telefonica is committed to its dividend targets. The company reiterated its plans to pay a dividend of €1.60 per share in 2011 and €1.75 per share in 2012.
The planned layoffs are expected to improve the company’s domestic profitably, which has seen a downswing of late due to the lingering economic downturn and intense competition.
In tune with its layoff plan, in early July Telefonica inked a deal with its labor unions over redundancy costs and the new system for wage increases. Under the new system, wage increases will be based on an employee’s productivity instead of the country’s inflation rate. We believe the new agreement will provide a boost to the company’s profits by curbing personnel expenses. In the first quarter, personnel expenses increased 3.2% from the year-ago quarter.
Telefonica would realize further savings from the planned job cuts that are not included in the three-year profitability and operating targets. For the next three years, Telefonica expects revenue to grow 1% to 4% annually and the operating margin to decline slightly from 38% in 2010. However, the company expects the operating margin to remain above the mid point of the 30–40% range.
Despite the layoff plan and expected improvement in Spain, Telefonica’s future earnings prospects remain gloomy. The company's debt has ballooned. It stood at €54.220 billion at the end of the first quarter. Though net debt was lower than €55.6 billion at the end of 2010, it was higher than €43.6 million at the end of 2009. Further, the company is investing heavily in its most attractive markets in Latin America, which will eat into its free cash balance.
Being one of the best performing regions, we believe Telefonica’s strong performance in Latin America, particularly Brazil, increased adoption of mobile broadband and continued investments in the expansion of broadband services (both fixed and wireless) are expected to stem some of the rot in its domestic operations. Telefonica is particularly well positioned in Brazil and Mexico, and is actively gaining market share from its dominant competitor, America Movil (AMX).
We are maintaining our long-term Neutral recommendation on Telefonica. For the short term (1–3 months), the stock retains a Sell rating with a Zacks #4 Rank.
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