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On Jul 17, we maintained our Neutral recommendation on Telefonica S.A.  . The company displays strength in fixed and mobile broadband activities across all markets. Business model restructuring, asset rationalization, new digital business and enhanced financial flexibility are expected to lift the company’s performance. However, several risk factors may impede its operating results going forward.

Why Maintained?

We expect Telefonica to deliver impressive revenues and profits from increased commercial activity, faster adoption of smartphones, expansion of Internet services and cost-cutting initiatives. The company has undertaken several efforts to enhance efficiency across European markets with the removal of handset subsidies and a redundancy program in Spain as well as network sharing agreement in the U.K.

Telefonica is on track to tap on the prospects in Latin America, especially Brazil by expanding its mobile and landline broadband services. The company is also widening its foothold in other regions like Argentina, Peru, Chile and Columbia by prioritizing the adoption of broadband facilities on the back of cheaper devices, tiered pricing and enhanced network capacities.

Madrid, Spain based Telefonica is restructuring its business model through a number of strategic steps. In April, the company announced its partnership with AirWatch, the U.S. based provider of enterprise-grade mobile device management, for delivering Security Mobile Device Management (SMDM) services for enterprises. The company also signed a strategic deal with second-largest Russian telecom operator, MegaFon. The deal is aimed at reducing equipment cost via joint purchases. All these moves will help Telefonica to fortify its presence in the international field.

Nevertheless, we prefer to stay on the sidelines due to the unstable macroeconomic scenario, intense competition from players such as Vodafone Group Plc. (VOD - Analyst Report), regulatory involvement and higher commercial expenses, all of which may limit the upside potential of the stock.

The Zacks Consensus Estimate for Telefonica’s earnings for the second quarter and full year are pegged at 33 cents and $1.27 per share, respectively. This reflects year-over-year decline of 8.3% for the next quarter and growth of 9.5% for 2013.

Other Stocks    

Foreign companies operating within the telecommunication sector that are worth taking note of include Nippon Telegraph and Telephone Corporation (NTT - Snapshot Report) and TELUS Corporation (TU - Analyst Report). While the former holds a Zacks Rank #1 (Strong Buy), the latter carries a Zacks Rank #2 (Buy).

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