This Contrarian Stock Idea Could Pay off Big Time

Europe, as we say in the South, “is a big ‘ol mess.” Authorities have put a tiny band aid on the wound, which is also known as “Greece.” Yet massive problems lie ahead in the other Euro-peripherals: Spain, Portugal, Ireland and Italy.

But, as you may know, I’m a huge fan of looking for opportunity in chaos, and I’ve found one in Portugal Telecom (NYSE: PT).

Portugal Telecom provides a full suite of telecommunications products such as fixed line, mobile, multimedia, data and corporate services throughout Portugal and in other countries through subsidiaries — but more on that later.

It’s not the prettiest picture considering the company is domiciled in the “P” of the “PIIGS,” where gross domestic product is currently contracting by 1.3%, the unemployment rate sits at a frustrating 14.8% and the youth unemployment rate hovers at a staggering 27.8%. For all practical purposes, that’s a depression. But if you haven’t clicked away from this article, thinking “I’d rather flush my money down the toilet,” then you likely know the value behind the “buy ’em when they’re hated” mantra. So here’s why there’s value in Portugal Telecom shares

1. 63% revenue growth
Portugal Telecom’s 2011 revenue should come in right at $4.21 billion. That’s a 63% jump from 2010 results of $2.58 billion. Although earnings-per-share results will most likely end up about where last year’s came in, an estimated $0.59 to $0.60 per share for 2011 compared with $0.61 for 2010. Overall, an improving revenue and stable earnings scenario is encouraging in the face of such horrendous macroeconomic conditions.

2. Low price-to-book
Shares trade at less than $0.80 on the dollar of their tangible book value. This means you’re getting a share of Portugal Telecom’s assets at a 20% discount. And this is an incredibly asset-rich company. From profitable subsidiaries to cash of $6.85 billion, the total value of the company’s assets weighs in at a hefty $20.35 billion against long-term debt of $8.3 billion. And while that $8.3 billion figure is high, most telecoms have high debt loads, and yet there’s still a lot of value locked away on this company’s balance sheet.

3. The dividend is safe for two years
According to management, the company is fully funded until 2014 and free cash flow from Portugal Telecom’s domestic businesses and income from foreign operations is sufficient to cover the commitment to the dividend. In 2014, the company has some nasty debt that needs to be rolled over, but two years should allow some breathing room to let credit markets reboot and to get asset sales loaded in the shoot.

4. Frontier market exposure
One of my favorite investment themes going forward is getting frontier market participation through buying more stable companies in the developed world that are making large, intelligent stabs into frontier market economies. As these economies emerge, naturally, telecom services become an increasingly important product to help drive that engine.

About 13% of Portugal Telecom’s business comes from its investment in telecom assets in continental Africa, an extremely wild and difficult frontier market. But the company’s track record making bets like this has been impressive. For example: Investments in Brazilian assets represent 46% of Portugal Telecom’s enterprise value. At one point many years ago, Brazil was a frontier market.

Risk to Consider: This is admittedly a riskier stock than most telecoms. The most obvious risk is, of course, being a company in a country at ground zero of the European fiscal crisis. Prospects on the continent as a whole are tepid at best. Persistent 14.8% unemployment and negative GDP growth isn’t conducive to growing the domestic business, which represents 44% of the company. Fortunately, Portugal Telecom is a cash flow horse because of the basic nature of the telecom business.

Action to Take –>  Shares of Portugal Telecom are classified as American Depositary Receipts, or ADRs for short. You should be able to trade them through most discount brokerage accounts. Shares trade at around $5.30 and have a forward P/E of 5.3. The dividend of about $0.85 cents per share dividend generates an almost incredulous yield of almost 16%. I wouldn’t hitch my wagon to that star but, according to management’s language, they’re committed to that number for at least two years.

OK, now for the fuzzy math. In the near-term, there’s no crystal clear fundamental catalyst like an upside earnings surprise or a booming economy. With that in mind, I’d set a 12-month target around $6.12. Shares were at that level four months ago. It appears that, at least for now, some of the fear in Europe has subsided, thanks to some decisive action on Greek debt. This should temporarily take pressure off of European markets and help shares rise in the near term. Combined with the dividend, that would equal a total return of more than 30%.