Portugal Telecom: High risk call

by Jack Adamo, editor Insiders Plus

Portugal Telecom, S.A. (PT) is a new buy recommendation, but one that we cautions is not for the faint of heart.

The firm is a broad-line telecom that offers services in Portugal, Brazil, sub-Saharan Africa, and Asia. Portugal is in economic trouble, but 60% of the company's revenues come from Brazil, which isn't.

Overall, consolidated revenues in the first half of 2012 increased by 25%, despite domestic weakness, partially due to strength in Brazil and partially due to its acquisition of a 25% share in Oi Telecom, Brazil's largest phone company.

Over the last 28 months or so, PT's stock fell 66% from $12/share to $4 before working its way back to $5.12 where it is now.

Some of that drop was due to weakness in the Portuguese economy, which should limit growth for a few more years, but the biggest fear was probably that Portugal would have to leave the Eurozone and use a newly formed currency that would undoubtedly be very weak.

I don't think those fears are without merit, but the ECB is bending over backwards to prevent that from happening with all the PIIGS. More likely the whole world will have some kind of Japan-like decades-long economic sleepwalk, due to all the forms of QE.

There are other concerns with PT. The dividend payout ratio is very high. I'm not worried about a dividend cut: That's a certainty. I'm worried about it going away entirely or virtually entirely.

Right now the shares yield something like 14%. I'd be surprised if the next dividend comes at an annualized rate of more than 5%.

The dividend varies in size and frequency. Sometimes it comes once a year, other times it's twice. So far it has never skipped a year entirely, going back to 1996 when it first started paying them.

The telecom space is brutally competitive anywhere in the world. With a large part of its business in Portugal, PT's job won't be easy, but I think the company can grind its way back to $8 or $9 a share within three or four years.

With an assumed dividend in the 4% range (at current cost) that would provide a nice return in the range of 18% to 29% per year.

If things stabilize over there, this could turn into a long-term holding. For now, however, it has to be considered speculative because of the economic and currency uncertainties, as well as the high payout ratio which leaves little wiggle room during times of financial stress.

Portugal Telecom, S.A. is a speculative buy up to $5.50. Buy it with a limit order only as the shares are somewhat thinly traded.

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