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Morningstar | Telefonica Reported Mixed 2Q Results With Weak Revenue, but Improved Margins; Shares Undervalued

Telefonica reported mixed second-quarter results, with weak revenue, but improved EBITDA margins. We plan on maintaining our EUR 13 per local share fair value estimate and narrow moat rating. We continue to believe the shares are significantly undervalued. The firm reported that revenue fell 6.3% year over year as it continues to be hurt by currency movements versus our full-year projection of a drop of 1.3%. However, on an organic basis, revenue grew 2%.

In Spain, its largest market, revenue increased 0.3%. Importantly, its “fusion” customers who subscribe to its wireless service and at least one fixed-line service grew 2% and now amount to 4.5 million subscribers. Fusion customers now account for 89% of its pay-TV base, 86% of its broadband base, and 82% of its contract wireless base. We are pleased to see this growth as these customers have lower churn and higher average revenue per user, or ARPU. Fusion ARPU grew 5.5% to EUR 89.50. We believe the enlarged fusion base will help drive further revenue growth in Spain.

In the U.K., revenue grew 5.6% in pounds, but only 1.9% in euros. While Telefonica grew its wireless base slightly in the U.K. and ARPU 1.8% in pound terms, the main revenue gains were handsets and other revenue that were up 13.4%. We have seen some stabilization in the U.K. market, which we expect will allow continued revenue growth in the country.

While the entire company has worked on controlling costs, we have particularly expected gains in Brazil after its acquisition of GVT, and in Germany following the acquisition of E-Plus, we finally saw significant margin expansion in these countries this quarter. This improvement flowed through to the parent with an adjusted EBITDA margin of 32.9% versus our 32.2% full year estimate. We believe there is additional room for margin expansion. For more on Telefonica Brasil and Telefonica Deutschland, please see our notes from July 25.

In the Latin American south region, revenue grew 8.7% in local currency terms, but declined 14% in euro terms. Mobile customers declined 4% to 43 million, but this was more than offset by ARPU gains of 30.9% in Argentina. Total wireless revenue grew 9.2% in local currency terms. Fixed-line telecom revenue increased 6.4% locally, mainly due to a 61.1% jump in fiber and cable based broadband subscribers, and a 9% gain in pay-TV customers. We expect these trends to continue, though we hope for some stability in the Argentine peso following the country reaching out to the International Monetary Fund for help.

In the Latin American north region, Mexico continues to struggle, but Colombia is performing better. Overall, revenue in the region declined 0.4% in local currency terms and 1.7% in euros. We have now seen improved results in Colombia from all three wireless operators and believe the worst of the price war is over and that all three can continue to grow as they did this quarter.