Telefonica S.A. (ADR) (TEF), Telecom Italia S.p.A. (ADR) (TI): The Bottom Line

The European telecom sector has been under pressure for a long time. High capex needs combined with the long European recession (which produced price wars across the region) have made margins tumble. That said, most European telecom companies have profitable investments made in high growth Emerging Markets (EM), above all in Latin America. Let’s take a look at the first quarter results of two of the main European telecom enterprises and try to see whether they represent a buying opportunity or not.

Telefonica: Brazil is now its biggest market.

Telefonica S.A. (ADR) (NYSE:TEF)‘s main market is, for the first time, outside the European continent. The company revealed that revenues from its Brazilian branch outgrew those coming from Spain. Actually, Latin American sales (Telefonica has businesses all across the continent, from Mexico to Argentina) accounted for more than 50% of the group’s total top-line.

Operations in Brazil became the company’s largest not only because Brazil is growing but also because Spain is shrinking fast. Revenues in Spain fell 18% Year over Year (YoY), well beyond my expectations. Besides, the whole European continent under-performed: revenues declined in the UK, Germany, Ireland and the Czech Republic.

Overall, revenues fell 9% YoY and the group’s operating income dropped 18%, while net profits surged by 21% YoY (last year Telefonica S.A. (ADR) (NYSE:TEF) wrote-off aggressively its Italian investments).

Taking into account all of the above, and with Spanish mobile tariffs still falling as I write this article,Telefonica Brasil mobile (Vivo) should keep on growing fast, boosted by accelerating smartphone adoption and less tariff competition than a year ago. Besides, Mexico should continue to accelerate as it benefits from a better competitive environment.

Trading on an adjusted 2013 equity FCF yield of 12% and at 5x EV/EBITDA, I think Telefonica S.A. (ADR) (NYSE:TEF) could be a good long term investment. The company is focused on reducing its debt pile (currently at $67 billion) and, at some point, Europe will turn around. That said, I wouldn’t expect the stock to gain momentum until the dividend is about to be reinstated, perhaps next year. I already own the stock, and now I know I bought too soon.

Telecom Italia looks cheap.

Over last month, the shares of Telecom Italia S.p.A. (ADR) (NYSE:TI), which is 10.5% owned by Telefonica S.A. (ADR) (NYSE:TEF), went up by almost 7%. That said, I still think the company looks cheap.

Telecom Italia S.p.A. (ADR) (NYSE:TI) trades at an adjusted 2013 equity FCF yield of 20%, 2013 3.5x EV/EBITDA and 5.8x P/E. This valuation represents a steep discount to its peer group. Besides, even if the European (and Italian) telecom market is performing (very) poorly, the company has an interesting presence in Latin America (through subsidiaries such as Telecom Argentina S.A. (ADR) (NYSE:TEO)).