When analysts downgrade telecom stocks close to a 52-week low, some investors wonder what more could go wrong. When this happens in one the PIIGS nations (Portugal, Italy, Ireland, Greece and Spain) — Spain in this case — they really wonder what to make of it. Merrill Lynch has downgraded Telefonica S.A. (NYSE: TEF) to Underperform from Neutral.
The company’s risk profile is not represented in a valuation premium relative to peers. Investors are paying heavily for a domestic asset valuation at a premium to peers, albeit reflecting some attractive domestic characteristics, and positive momentum through the second half. Comparisons to cable multiples are flawed, in the opinion of Merrill Lynch. In a sensitivity analysis that values domestic assets using a post-synergy cable multiple of 8.4-times EBITDA, and listed assets in Brazil and Germany using current market values, the brokerage firm derived a potential valuation of €10 per share.
Following the second quarter, and adopting the latest currency forecasts, Merrill Lynch lowered its fiscal 2015 and 2016 Revenue estimates by -1.5% and -4.9%, respectively. The new price objective is €12.5.
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Just as the brokerage firm flagged an O2 sale as a potential positive in its fourth quarter research from 2014, Merrill Lynch now flags its execution as a potential risk with the U.K. CMA (Competition Markets Authority) set to petition for regulatory claw back from the European Union sometime in September. To be clear, the firm continues to expect the deal to pass at the EU level, but even a small risk of disruption applied to a significant event warrants some element of caution.
According to Merrill Lynch:
Telefonica’s growth is set to improve, however we think this is more than priced into valuation, especially given its relatively higher risk profile than peers. With increasing currency volatility and macro downturn we forecast ongoing earnings risk to the downside.
Each one of Telefonica’s American depositary shares equates to one ordinary share of the company. Telefonica ADSs were down 1.9% at $13.37 on Wednesday. The stock has a consensus analyst price target of $14.98 and a 52-week trading range of $13.27 to $16.40.
As a reminder, Telefonica’s ADSs are valued at half of what they were in 2011. They have been largely range-bound for the past three years.
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