Telefonica is the former Spanish incumbent telecom operator. The company operates in 12 countries and provides fixed, mobile, broadband network, and television telecommunication services to about 350mn customers. Movistar, Vivo, and O2 are its best-known brand names. Telefonica maintains market-leading positions in Spain as well as Brazil, and has a significant presence in Germany, the UK, and various other Latin American countries.
As rating headroom remains limited, Telefonica credit is anchored in the low-BBB rating level. The company recently reported strong Q3 results, with organic revenue and EBITDA growth exceeding consensus expectations. Also of note is the performance in the domestic market, which continued to improve even though growth remained slightly negative. Thanks to robust cash generation, net debt decreased to EUR 26.5bn (from EUR 27.5bn in the previous quarter), and the issuer’s leverage ratio improved to 2.51x (from 2.61x in Q2). During the recent capital markets day, Telefonica also provided updated operating targets over 2023-2026, including annual revenue growth of 1%, annual EBITDA growth of 2% (driven by cost reduction efforts), and annual free cash flow growth of 10%. Additionally, the company announced a target band for leverage of 2.2x- 2.5x, and we believe that the issuer is aiming to reach the lower end of the range.
With decreasing capex intensity and increasing free cash generation, one can anticipate rating headroom to grow – even though limited as competitive pressures in Spain and Germany remains high. Telefonica’s EUR-denominated senior instruments offer a premium compared to most other investment grade rated European telcos.
Given the business highly cyclical structure, there is limited value in the issuer’s hybrids, particularly in Telefonica’s perpetuals with lower reset spreads. There is ongoing investor concern about extension risks, irregular management execution which could potentially could lead to a S&P downgrade and classify Telefonica to the sub investment grade category.
The Spanish’s government recent decision to acquire a stake of up to 10% in the issuer via state holding company SEPI as a positive. TEF credit is appropriate for investors seeking above average investment risk opportunity.