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Stock Strategist

Telefonica Still Undervalued

Despite recent struggles in Latin America, the company looks set for improving margins and returns on capital.

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 Telefonica (TEF) is one of the largest telephone companies in the world, with particular strength in Spanish- and Portuguese-speaking countries. The firm's strategy of dominating these markets worked well for years, but this domination has struggled more recently.

The problems began when the company acquired Portugal Telecom's stake in Vivo, its Brazilian wireless business. The debt that Telefonica took on for this acquisition, along with the worsening of the Spanish recession, caused management to lose financial and operating flexibility. While we liked Telefonica's full control over its Brazilian operation, we thought it overpaid. We also didn't like its aggressive dividend policy, which raised the dividend faster than free cash flow growth. This came to a head in 2012, and the firm first cut and then eliminated the dividend in order to pay down debt.

Allan C. Nichols does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.