Telefonica Sets 3-Year Growth Plan

Spanish telecom giant Telefonica (TEF - Analyst Report) set its annual revenue growth target at 1% to 4% through 2013 at its investor meeting in London.

A weak Spanish market remains a concern for the company as customers are switching to cheaper offers from its competitors. Telefonica expects its operating margin to decline slightly over the three-year period from 38% earned in 2010, but remain above the mid point of the 30–40% range.

We believe Spain is not working in favor of Telefonica. The economic downturn in that country has been more than expected and is likely to drag the company’s profits and liquidity. Further, the company’s Spanish revenue continues to be affected by the ongoing reduction in mobile termination rates, which is the fee that operators charge each other to connect calls.

However, weak Spanish operations are expected to be fully offset by strong growth in Latin America and Europe. Latin America is one of the best performing areas and remains the principal growth region for Telefonica. This segment continues to post healthy subscriber additions on a quarterly basis. The company’s subscriber base is expected to expand to more than 340 million by 2013 from 287.6 million reported in 2010.

Telefonica continues to invest in growth and transformation projects, fostering the development of broadband services (both fixed and wireless). The company will invest €27 billion, distributed equally over three years (2011–2013). We believe increased adoption of mobile broadband will fuel earnings growth ahead.

The company reiterated its commitment to pay €1.75 per share as dividends in 2012. Telefonica also plans to distribute at least the same level of dividend in the years to follow through dividends or share buybacks.

Telefonica is particularly well positioned in Brazil and Mexico, and is actively gaining market share from its dominant competitor, America Movil (AMX - Analyst Report). Moreover, the consolidation of Vivo Participacoes (VIV - Analyst Report) with the Brazilian fixed-line voice and broadband unit, Telesp (TSP), in October 2010 enables Telefonica to offer full competitive bundled services.

We are currently recommending our long-term Outperform rating on Telefonica supported by the Zacks # 1 (Strong Buy) Rank.

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