Sunday, October 31, 2010

Dialing for Dollars in Argentina

Telecom Argentina S.S. (TEO) focuses its efforts in offering a full range of integrated fixed and wireless services. The company’s mobile strategy is oriented towards improving the mix of postpaid users by promoting 3G services, better customer service and high-end handsets. Mobile data services have room for growth despite VAS accounting for 38% of service revenue, as most revenue from VAS relates to text messaging. The strategy on fixed business continues to center on bundle offerings that include voice and broadband services.

TEO has strong operating performance driven by mobile services, solid market positions, diversified portfolio of services with multiple platforms and a strong financial profile. There are certain risks in investing in Argentina. Among the risks are political instability, an unfavorable regulatory environment and currency risk, among others.

In a recent development, Telecom Italia (TI) is to take control of TEO. Under the plan, TI will have a controlling stake in Sofora, a holding company that in turn has a controlling stake in Telecom Argentina.

The company’s favorable prospects are borne out by the financial statements. The statements show consistent growth built on a stable and strong balance sheet.

Sales for 2Q10 came in at $877.6 million or 18.6% more than the $740.2 million reported in 2Q09. Sales for the TTM totaled $3,337.7 million as compared to $2,862.4 in the year-ago period and $3,094.0 million for FY09. The average growth rate for sales over the past five years is 22.2%. Six analysts make sales projections for TEO. The consensus projection for FY10 is $3,648.02 million and $3,702.55 million for FY11.

EPS for 2Q10 was $0.58 as compared to $0.45 in the year-ago period. EPS TTM is $2.01 as compared to $1.35 for the year-ago period and $1.60 for the year ending December 2009. Analyst forecasts for FY10 range from $2.26 to $2.59 with an average of $2.39. Projections for FY11 range from $2.34 to $2.73 with a consensus of $2.47. Y-O-Y, EPS grew at 48.9% and 25.6% when compared with FY11. EPS has grown at the rate of 29% over the past five years.

Free Cash Flow has been much more volatile over the years. At $1.46 TTM, it is down (25.1%) from the year-ago period. The five year growth rate for FCF is a paltry 0.6%.

A big plus for TEO is the dividend. It is currently paying a dividend of $2.15 per share, providing a yield of about 7.9%. Clearly, a dividend in excess of earnings or cash flow is unsustainable and represents a red flag.

The balance sheet reflects strength. Cash and ST investments total $301.9 million whereas long term debt is $18.7 million and other long term liabilities add another $249.3 million to the tab. Total liabilities are less than 5X free cash flow.

The company has steadily increased its gross profit margin. The normalized margin is 43.02%. For TTM, the gross margin rose to 50.1%. This compares favorably with the industry median of 48.9%. We see even better improvement in operating margins. The normalized operating margin for TEO is 14.85%. The most recent operating margin is 21.9% whereas the industry median declined to (0.8%). Net margins have been up and own over the years. In FY05, the margin was 20.1%. The following year, the margin declined to 7.8%. Since then, net margin has grown to 11.9%; better than the industry median of 0.3%.

TEO reports a return on equity of 29.1%, as compared to the industry median of 14.4%. However, reported ROE has steadily declined as the company deleveraged. Return on assets have steadily grown and is now at 14.4%.

Deleveraging clearly shows up in the debt management ratios. Total liabilities to total assets are 51.1% compared to the normalized ratio of 65.78% and the industry median of 74.5%. Lon term debt to equity has declined to 1.4% from 242.9% in 2004. Long term debt to capital is also 1.4%.

The company is better managing its assets. Receivable turnover is up to 9.7X compared to a five year average of 8.78X and the industry median of 7.7X. Asset turnover improved to 1.2X from 0.3X in 2003 and is better than the industry median of 0.7X. Finally, inventory turnover stands at 24.5X as compared to the industry median of 16.9X.

With a P/E TTM of 11.9X and a P/E est. EPS of 10X, TEO does not look expensive when compared to the industry PE of 14.4X.

DISCLOSURE: Author is long TEO.

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