Telefónica Premium

A little swagger can be a healthy thing, as long as you can back it up. Telefónica, the Spanish telecoms group, was in a swaggering mood last week as it outlined plans to increase its yearly dividend by 22 per cent next year. Plans to pay a dividend of €1.40 a share, rising to at least €1.75 by 2012, reflect confidence that Telefónica can deliver even as its home market – the source of more than half of its free cash flow – languishes in its worst recession in decades.

It would take a brave investor to bet against Telefónica. The group’s shares have outperformed the FTSE global telecoms index by 74 per cent in five years thanks to strong management and deft cost-cutting.

But with recovery in Spain unlikely before 2011, future out-performance will hinge on robust trading in Latin America and recovery in Europe. Telefónica faces challenges on both fronts.

Competition in the UK, its second-biggest European market, is set to increase now that O2 is no longer the exclusive provider of Apple’s iPhone. Latin American sales, meanwhile, have been flattered by high inflation in Venezuela, while prices in Brazil, the region’s most important growth market, remain under pressure.

Telefónica has room for manoeuvre – its balance sheet remains solid, with net debt of two times earnings before interest, tax, depreciation and amortisation. Its promise to raise dividends did not include a similar commitment to share buy-backs, and the company is eyeing €1bn of extra cost savings next year in case sales do not prove as robust as hoped. Even so, Telefónica’s aggressive stance suggests management are convinced they can overcome mounting pressures.

Shareholders, hungry for a potential dividend yield of 7.4 per cent next year – against an average of 6.8 per cent for the sector – will be counting on it.

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