2 of the World's Highest-Yielding Telecom Stocks

Friday, December 9, 2011 - 11:00am

by Lisa Springer

As an income investor, one of my favorite holdings is telecom stocks. Their stable business models and generous yields leave me at ease.

Dividends are also often higher than other sectors because of the strong cash flow these companies generate and their ability to return much of it to shareholders. In addition, telecoms tend to be resilient during downturns, so they usually make good defensive holdings. The logic is simple: most of us will cut discretionary spending in other areas before we would even consider getting rid of our cell phones and Internet access when times get tough.

Foreign telecoms are even more attractive -- they often yield more than their U.S. counterparts, while still offering an element of safety. Right now, though, I'm steering clear of European telecoms because they're a bit too volatile for my taste as a result of the region's ongoing economic crises.

Here are two foreign telecoms from other areas of the world that have caught my eye because of their dominant market positions and rich yields.

1. Cellcom Israel (NYSE: CEL)
Forward yield: 10%

Cellcom is Israel's leading cellular-service provider, with a 34% market share and more than 3.3 million subscribers. This company, along with Partners Communications (Nasdaq: PTNR) and Bezeq (IT: BEZQ), enjoy a virtual monopoly in Israel's $8 billion mobile phone market. This year, the Israeli government made reforms intended to reduce the market dominance of the "Big 3" by giving other telecoms incentives to expand their own networks. But barriers to entry remain high.

Israel's cellular-phone market is relatively mature, which means Cellcom isn't really a growth story. In fact, the company's earnings dropped 40% to $53 million in this year's third quarter in comparison with the same quarter last year. The decline was caused by price erosion and churn, the result of new rules making cell-phone contracts easier to terminate. Right now, for instance, all of Israel's cellular-service providers are experiencing churn rates of 7% or higher. But my guess is that churn rates will quickly fade, leaving dominant providers such as Cellcom still in control.

While Cellcom isn't a growth stock, the company is an impressive cash flow machine. Cellcom generates 34% EBITDA margins and has produced operating cash flow in excess of $453 million in the past 12 months. Return on investment (ROI), a key profit measure for telecoms, is an impressive 20.5%, or nearly three times the telecom industry average ROI of 7.5%. Cellcom has ample cash flow to cover dividend payments, which totaled $372 million in 2010.

Shares of Israeli telecoms are taking a beating this year because of investor fears regarding regulatory reform. Cellcom's price has dropped roughly 50% so far this year, and the stock is valued at just six times earnings (the stock currently trades for roughly $16). Despite a growth slowdown caused by regulatory reforms, analysts still look for Cellcom to produce 12% yearly earnings growth in the next five years. In addition to the stock's cheap valuation, Cellcom offers an eye-catching 9.6% forward dividend yield and the cash flow needed to sustain it.

2. Philippines Long Distance Telephone (NYSE: PHI)
Yield: 6%

This company has 47.7 million cellular subscribers and provides a diverse range of telecommunications services across the Philippines, including wireless, fixed-line and information and communications technology. The investment case for Philippines Long Distance hinges on the long-term growth story for the Philippines.

The Philippines telecom market is basically split between Philippines Long Distance and a smaller rival, Globe Telecom. In my opinion, a great way to play call-center growth is to own Philippines Long Distance.

This country, along with South Korea, Vietnam and Turkey, is among the world's most promising emerging markets. The Philippines has a stable manufacturing and banking sector, and has become a major destination for offshore call centers. Well-known companies such as Wipro (NYSE: WIT), Siemens (NYSE: SI) and Accenture (NYSE: ACN) have already established call centers in the Philippines, greatly benefiting local telecoms. Industry forecasts are for 9.2% yearly growth in the Philippines call-center segment in the next several years.

Investments in network modernization and the U.S. dollar devaluation (about 26% of revenue is earned in dollars) caused the company's net income to decline 4% to $703.4 million in the first nine months of 2011 compared with the same period a year earlier. Free cash flow (i.e. cash flow after capital expenditures), however, rose 11% to $839.1 million from $746.8 million. EBITDA margins were exceptional at 59%, and the company has generated cash flow from operations totaling $1.8 billion in the past 12 months.

These solid numbers are more than enough to cover $938 million of annual dividend payments. Philippine Long Distance's share performance this year has roughly tracked the S&P's 2.7% gain, and is trading at a moderate price-to-earnings (P/E) multiple of 12.

The stock currently yields 6.4%. Dividends have risen 31% in the past five years, so it would not be unrealistic to see this payout rise in coming years.

Risks to Consider: Israel and the Philippines withhold taxes on dividends paid to foreigners, but the good news is you can reclaim this money in the form of a tax credit. Investors should also note currency risk is associated with both stocks. Current dividend rates aren't guaranteed, either. Unlike their U.S. counterparts, foreign companies often link payout directly to earnings, so dividend rates could vary greatly from one period to another. (That said, currency rates and dividend payouts could also work greatly in your favor.)

Action to take--> Between the two stocks, my top pick is Philippines Long Distance because of its rising free cash flow and robust cash flow coverage of the dividend. Cellcom is attractive based on its very generous yield, but I consider this stock somewhat riskier due to continued uncertainties regarding the long-term effect that Israel's regulatory reform will have on the country's telecom industry.

Lisa Springer does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.