TEFOF - Telefonica Brasil: Q2 Earnings Reinforce Resilient Dividend Outlook

2023-08-31 04:21:07 ET

Summary

• Telefônica Brasil's Q2 results demonstrate robust cash flow growth and CAPEX reduction, reinforcing its reputation as a strong dividend payer.
• While the stock's appreciation this year limits short-term gains, a substantial long-term valuation gap is evident, though potential risks include market entry and political factors.
• Despite challenges, Telefônica Brasil's consistent dividends and positive Q2 performance support a bullish investment outlook.

Operating under the brand Vivo in Brazil, Telefônica Brasil ( VIV ) holds a prominent position in the country's fiber optic industry and demonstrates robust cash generation capabilities. This advantageous position allows the company to finance its expansion investments while leveraging potential market opportunities.

Telefônica Brasil's second-quarter results were strong, showcasing a continuous increase in operating cash flow and a simultaneous reduction in CAPEX.

In conjunction with these factors and its modest debt levels, the company stands out as a strong dividend provider, consistently exceeding the 6% dividend yield benchmark discussed in my previous article.

Reaffirming my positive perspective post-Q2 results, I continue to view Telefônica Brasil as possessing growth potential. This perspective is driven by its valuation compared to industry averages and key competitors. Furthermore, the company's status as a reliable dividend provider remains unshaken, presenting the potential for expansion in the upcoming years.

Latest results

Telefônica Brasil has reported robust second-quarter results, showcasing several positive trends, such as a price adjustment that boosted mobile and fixed revenues, a slowdown in total costs, and a steady net profit.

The company experienced substantial revenue growth, reaching $12.7 billion, marking a year-on-year increase of 7.6%. Notably, revenues from mobile and FTTH (Fiber to the Home) services grew by 10.4% and 14.3%, respectively.

A significant highlight was the growth in mobile Average Revenue Per User (ARPU) of 11%, with the post-paid segment experiencing an impressive 8.4% year-over-year increase (compared to a 1.8% decrease in Q1 2023) and the prepaid segment showing a 7.5% year-on-year growth (versus 2.9% in 1Q23). These gains were driven by recent price adjustments that the company implemented.

However, prepaid revenues declined by 1.6% year-over-year due to the migration of prepaid users to control plans, which ultimately benefits the overall dynamics of mobile service revenues. Telefônica Brasil's reasoning behind this shift is to streamline the prepaid offerings and incentivize migration to control plans. Consequently, the basic prepaid offering changed from a weekly plan (R$11.99 for 3 GB) to a fortnightly plan (R$15.00 for 4 GB).

The 10.4% year-on-year growth in mobile service revenues was primarily propelled by post-paid revenue, which includes Machine-to-Machine (M2M), cards, wholesale, and other elements. This segment benefited from a growing customer base, annual price adjustments, and historically low churn rates (cancellations).

Total costs exhibited a quarterly deceleration of 1.7% due to enhanced operational efficiency, amounting to R$7.6 billion. However, a noteworthy year-over-year increase of 5.4% was observed, particularly in the Cost of Goods Sold (COGS), which expanded by 6.4% due to the revenue growth. Operating costs also increased by 5.0% year-over-year to reach R$5.3 billion, mainly attributed to expenses linked to the Business-to-Business (B2B) segment.

Moreover, EBITDA grew by 11.1% compared to the first quarter of 2022, totaling R$5.08 billion. The EBITDA margin expanded by 1.2 percentage points year-over-year, primarily driven by the strong performance of the mobile service division.

Lastly, net profit amounted to R$1.1 billion, marking a significant increase of around 50% year-on-year. The net financial result recorded a negative value of R$486 million in the second quarter of 2023, indicating a 19.2% reduction in financial losses compared to the same period in 2022.

Lowering CAPEX, decreasing debt

Telefônica Brasil reduced its capital expenditures ((CAPEX)), with investments totaling R$2.35 billion in the second quarter. This marked an 8.6% year-on-year decrease, equivalent to 18.5% of net operating revenue for the quarter, reflecting a 3.3 percentage point reduction compared to the previous year.

These investments were primarily focused on enhancing the mobile network, emphasizing the rollout of 5G technology in cities with populations exceeding 200,000. Additionally, there was significant investment in expanding the fiber network infrastructure.

At the close of the second quarter, the company's net debt amounted to R$12.16 billion, demonstrating a decline of 7.4% compared to the same period in the prior year. The net debt/EBITDA ratio of 0.7x underscores the company's low leverage.

While the reduction in investments by Telefônica Brasil positively contributes to cash generation and facilitates dividend distribution, Christian Gebara, the company's CEO, indicated that the company remains committed to expanding its presence in areas where regional internet service providers (ISPs) hold sway.

The executive emphasized the necessity of industry consolidation, considering the presence of more than five thousand operators in the market. However, he noted that Vivo (Telefônica Brasil) has yet to identify an asset that aligns with the company's criteria for participation in the consolidation process.

Dividends are safe and sound

Investors in Telefônica Brasil can find assurance in the stability of dividends, as the company is well-positioned to provide more robust dividend payouts this year.

Demonstrating consistent positive trends, Telefônica Brasil has reported a consecutive 36.4% increase in cash flow for the second semester. This development is particularly encouraging considering the company's steadfast dividend policy, which boasts an average payout rate of 100%.

It's important to highlight that Telefônica Brasil's parent company is Telefónica S.A. ( TEF ), creating a fundamental commitment to channel profits back to the controlling entity through dividends.

While last year saw Telefônica Brasil yield a dividend of 6.1%, marking the lowest level since 2017, the future appears promising. There's a gradual improvement on the horizon, with the projection of a 6.2% yield gaining traction. This positive outlook stems from the company's dual approach: increasing operating cash flow and reducing capital expenditures ((CAPEX)).

Telefônica Brasil is still undervalued

Telefônica Brasil's shares are currently trading at a forward price-to-earnings (P/E) ratio of 14.4x, which is 7.5% below the average for the telecom industry. This suggests that the shares are currently being offered at a discounted value. This discount becomes even more pronounced when directly compared to one of its main competitors, TIM S.A. ( TIMB ), which trades at a higher forward P/E ratio of 15.6x.

When considering the predictability of Telefônica Brasil's financial results, the earnings per share ((EPS)) projection for the upcoming five years indicates a growth of 160% by 2027. This substantial growth projection would lead to a considerably reduced P/E ratio of 5.59x, highlighting the potential undervaluation of the company's shares.

The bottom line

Telefônica Brasil's recent second-quarter results have been positive, reinforcing its reputation as a strong dividend payer by demonstrating increased operating cash flow and ongoing CAPEX reduction.

However, investors need to manage their expectations appropriately. The stock's appreciation of more than 30% over the past year likely constrains short-term gains. Nonetheless, I perceive a substantial valuation gap to be filled for the company in the long run.

While Telefônica Brasil maintains higher tariffs than its competitors, it faces the risks posed by potential new entrants into the market. Moreover, the company operates within a country characterized by significant political risk, potentially leading to regulatory shifts. Telefônica Brasil is directly influenced by the dynamics of the Brazilian economy . Although inflation is relatively managed, the country still grapples with a notably high-interest rate, projected to reach 11.75% by the end of 2023.

Nevertheless, the Q2 results released by Telefônica Brasil instilled confidence in my bullish recommendation for the company's shares. I foresee the potential upward movement in its share price due to its attractive valuation multiples. Furthermore, the company's ability to consistently distribute dividends in the forthcoming years contributes to its investment appeal.

For further details see: