Spanish telecom giant Telefonica (TEF) reported disappointing first half results with earnings per share of €0.70 ($1 per ADS) declining 16.1% year over year.
Net income dropped 16.3% year over year to €3.2 billion ($4.6 billion) due to lingering economic domestic downturn, intense competition and increased operating costs. The customers are switching to cheaper offers from smaller rivals, leading to lower revenues and earnings for the company.
Consolidated revenue rose 6.3% year over year to €30.89 billion ($44.4 billion) in the reported quarter. Despite weaker operations in Spain, Latin America and Europe drove the double-digit revenue growth.
Consolidated operating expenses increased 8.2% year over year to €20.31 billion ($29.22 billion). Operating income before depreciation and amortization (OIBDA) grew 3.7% to €11.3 billion ($16.3 billion), resulting in OIBDA margin of 36.6%, down from 37.5% in the year-ago quarter.
Segment Results
Telefonica Espana: The operator’s Spanish revenues fell 6.1% year over year to €8.75 billion ($5.98 billion), hurt by declines in both wireline and wireless businesses. Wireline revenues dropped 5.9% year over year to €5.35 billion ($7.7 billion) due to lower access, voice and Internet broadband revenues partially offset by higher data and IT revenues.
Revenues from wireless operations fell 6.1% to €3.95 billion ($5.68 billion) on account of lower mobile service revenues, resulting from a reduction in mobile termination rates. This was partially offset by improved handset sales.
Telefonica Europe: Revenues from Europe increased 2.2% year over year to €7.67 billion ($11 billion), buoyed by modest performance in UK and strong growth in Germany, partially offset by strong competition in the Czech Republic and continued economic uncertainty in Ireland.
Revenues from UK inched up 1.1% year over year to €3.45 billion ($4.96 billion) in the reported quarter. Revenues from Germany showed a substantial 7.5% increase to reach €2.44 billion ($3.51 billion), while Ireland and Czech Republic declined 11.3% and 1.4% to €372 million ($535 million) and €1.1 billion ($1.58 million), respectively.
Telefonica Latin America: Latin America continues to grow at a faster pace in the first half and remains one of the best performing regions. Revenues climbed 18.4% year over year to €14.12 billion ($20.31 billion), driven largely by Brazil, followed by Argentina (11%), Chile (8%), Venezuela (8%), Peru (7%) and Mexico (6%).
Revenues in Brazil (the largest market) increased 6.4% year over year to €7.12 billion ($2.47 billion) backed by strong economic growth. Telefonica’s Brazilian wireless business showed a massive 136.7% increase in revenue to €4.3 billion ($6.2 billion) from the year-ago quarter. Wireline revenues rose 8.9% year over year to €3.61 billion ($5.2 billion).
Subscriber Statistics
In the first half, total customer access reached approximately 295 million, up 6.2% year over year, with 8% and 5% year-over-year growth in Latin America and Europe, respectively.
On an annualized basis, mobile access rose 8% to 227.3 million customers and mobile broadband access increased to 29.8 million. Total retail fixed broadband access grew 8% to 17.6 million, driven by the rapid adoption of bundled services (voice, broadband, and television).
Pay TV access reached 3.1 million, up 16% year over year. Fixed telephony access dropped 3% to 40.7 million subscribers in the first half.
Liquidity and Capital Expenditure (CapEx)
Telefonica exited the first half with net debt of €56.42 billion ($81.17 billion), up from €55.593 billion at the end of 2010.
CapEx fell 10.6% year over year to €3.84 billion ($5.52 billion) in the first half. Free cash flow improved to €3.13 billion ($4.5 billion) from €2.5 billion in the year-ago period.
Our Analysis
We believe Spain is not working in favor of Telefonica. The economic downturn as well as ongoing reduction in mobile termination rates in that country has been more than expected and is likely to drag the company’s future profits and liquidity.
In addition, the company’s highly leveraged balance sheet, increasing competition (especially in Brazil and UK) and regulatory involvement might limit the upside potential of the stock.
In order to improve its domestic profitability, Telefonica plans to dismiss 6,500 employees in Spain over the next three-years. This move will lead to further savings 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 operating margin to decline slightly from 38% in 2010.
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 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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