Bullish indicating open at $55-$60, IPO prices at $37
Investing.com -- Bernstein has initiated coverage of Telefónica SA with a "market-perform" rating and a target price of €4 per share, suggesting a downside of approximately 8% from its current trading level of €4.33.
In the note dated Tuesday, the analysts flag several critical structural challenges that need to be addressed for Telefónica to achieve sustainable recovery in valuation and financial performance.
The note follows changes within the company, including a shareholder reshuffle prompted by Saudi Telecom’s acquisition of a 9.9% stake in Telefónica.
This move led to increased stakes from the Spanish government and Criteria Caixa, reducing the company’s free float.
Additionally, Telefónica replaced its CEO and COO, a step Bernstein views as overdue but insufficient without a clear, strategic direction.
Central to Bernstein’s analysis are four major structural weaknesses. Telefónica is asset-rich but has struggled with growth, particularly in fibre infrastructure.
Although it leads in fibre coverage, particularly in Spain and Brazil, Telefónica’s capex-to-sales ratio has remained below the European average, reflecting underinvestment.
Widespread competition and fibre duplication have eroded its pricing power, transforming Telefónica from a price-maker to a price-taker.
Another critical issue is the company’s ongoing leverage problems. Despite a 30% reduction in net debt since 2019, its EBITDA has declined at a similar rate, resulting in limited improvement in leverage metrics.
Telefónica’s most recent net debt/EBITDA ratio stands at 3.7x, just below the 4x threshold for investment-grade status.
However, this improvement is primarily due to methodological changes rather than operational success.
Additionally, Telefónica’s financial reporting has been skewed by off-balance-sheet structures, particularly through joint ventures in fibre infrastructure.
Bernstein estimates that reconsolidating these investments would increase capex by approximately €1 billion annually and reduce free cash flow by 30%, reversing the modest reduction in net debt expected over the 2025–2027 period.
The company’s generous dividend policy further complicates its financial position. Telefónica has committed to paying a €0.30 per share dividend for 2024–2026, yielding 6.9%.
Bernstein criticizes the practice of inflating free cash flow to fund this dividend, particularly by including cash flows from heavily leveraged joint ventures and excluding recurring costs like spectrum payments.
Adjusted for these factors, Telefónica’s actual free cash flow in 2024 is estimated to be €230 million lower than reported.
Bernstein also questions the strategic rationale behind Telefónica’s geographical footprint. The company’s portfolio has grown through opportunistic expansion, particularly in underperforming markets like Brazil and the UK.
Bernstein suggests that Telefónica may not be the "natural owner" of many of these assets and advises against a fire-sale approach to divestitures, citing Vodafone’s cautionary experience with similar strategies.
In terms of valuation, Telefónica trades at a 5% premium to its peers on an EV/OpFCF basis, reflecting emerging market risks.
While the stock appears discounted at 12.2x EV/OpFCF for 2025 estimates compared to the sector average of 14.9x, excluding emerging market operations results in a 15.3x multiple, above the European average.
This indicates investor concerns about the sustainability of cash flows from Telefónica’s more stable regions.
The financial forecasts for Telefónica include an adjusted EPS of €0.36 for 2024, €0.28 for 2025, and €0.30 for 2026.
The dividend per share is projected to remain at €0.30 across these years. Bernstein’s adjusted P/E ratios are forecasted at 12.0x for 2024, 15.5x for 2025, and 14.4x for 2026.