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Telefonica (TEF): Moody's Cuts Credit Rating to Baa3

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According to recent reports, Spanish telecom behemoth Telefonica SA (TEF - Free Report) has been  downgraded by International credit rating agency, Moody's Investors Service, commonly referred to as Moody's. The downgrade follows Moody's warning that Telefonica needs to reduce its debt by the end of 2016. Moody's recent decision has altered the outlook of Telefonica's long-term senior unsecured ratings.

Cash and Liquidity

The fallout of the company’s IPO plans for its infrastructure division Telxius was a major setback. Telefonica also attempted to establish its U.K. wireless unit, O2 UK, as an IPO to lessen its debt burden. Notably, O2 UK is a dominant wireless player in the U.K. along with 3UK and Vodafone Group Plc. (VOD - Free Report) .

Meanwhile, the company exited the third quarter of 2016 with total debt of about €61,171 million (about $68,267 million), up from €60,087 million ($67,057 million) at the end of 2015. Telefonica ended the third quarter with cash and cash equivalents of €3154 million (around $3,159 million) compared with €2,615 million (roughly $2,198 million) at 2015-end. Such high debt levels and declining cash flow may deal another blow to its credit ratings.

Rating Cut

Reports state that Moody’s downgraded the guaranteed subsidiaries of Telefonica from Baa2 to Baa3, and preferred stock ratings from Ba1 to Ba2 and short-term ratings to Prime-3 from Prime-2. Telefonica's recent financial statements clearly imply that the company will not be able to meet the deleveraging targets by Dec 2017, which justifies the rating downgrades.

Meanwhile, the company has been striving to bring down debts through modified financial strategies such as organic free cash flow generation, vending of non-strategic assets on an opportunistic basis and reduction of dividend payments. The outlook on the ratings remains stable. Although the company’s decision of reducing dividend seems to be a step in the right direction to preserve cash and reduce debt, but this strategy will delay its efforts to de-lever.


The company operates in the highly competitive markets of Spain, U.K. and Germany. Also, emerging market risks and foreign currency exchange rate risks remain potent headwinds. Moreover, the company has consolidated assets wherein Telefonica Deutschland owns 63%, Telefonica Brasil owns 74% and Telefonica de Colombia has 68%.

Outlook Stable

The outlook on the ratings is considered stable as Moody’s expects Telefonica to improve on an organic basis through its strong operating performance in Spain, U.K. and Germany. Also, the company’s Brazilian operations are immune to economic downturns. Further, an improved domestic market coupled with rational competition focused on value and strong economy should help the company rake in more profits. The rating at Baa3 is well positioned wherein Moody's expects net adjusted debt/EBITDA to progressively improve from 3.7x in 2016 to around 3.2x in 2018.

The company’s focus on enhancing its networks through investments and data monetization should help boost revenues as well.

Zacks Rank and Stocks to Consider

Telefonica currently carries a Zacks Rank #3 (Hold). Here are some companies that have the right combination of elements to post an earnings beat this quarter.

Western Digital Corporation (WDC - Free Report) currently has a Zacks Rank #1.You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. The company’s earnings beat the Zacks Consensus Estimate in three of the previous four quarters.

Mindbody Inc. (MB - Free Report) has a Zacks Rank #2 (Buy).The company’s earnings surpassed the Zacks Consensus Estimate in allof the previous four quarters.

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