Recent Sale

I don’t write articles like this very often, because as a long-term dividend growth investor I don’t sell stocks very often. But, I did recently close out a position of mine that I had been holding for most of the year. I did this not because of a reduction in share price, creating a loss for me, but because of a deterioration in what was already poor fundamentals. Unfortunately, I make mistakes (often!) and I certainly made one with investing with this company. I chased yield, and I didn’t analyze the fundamentals as much as I should have.

I sold all 125 shares of my holdings with Telefonica S.A. (TEF) (ADR) on 12/7/11 at $18.44 per share. I want to make it clear that I did not sell my TEF holdings because of fear, or because the share price has gone down. I usually look forward to a drop in the share price of a holding of mine, as I simply look at that as an opportunity to average down on my holdings. I sold TEF because of poor fundamentals. The debt load is, in my opinion, unsustainable and out of control. Management has not really put a clear and concise plan in place to reduce it going forward. They have talked about selling underpeforming assets, but have not been clear as to which are on the table. It seems that the poor assets on the books are unattractive to outside investors or companies. At the end of 2010, they had over 53 billion euros in long-term debt (almost $72 billion dollars) and there appears to be no plan in view to reduce that. The debt to equity ratio currently sits at 2.6, which is too high even for a telecommunications company in my opinion.

As these debts reach maturity TEF must either pay that mature debt or roll it over into new debt. The problem is that with the euro zone crisis, and Spain’s individual problems, the interest rates on TEF’s debt is likely only to increase in the short-term. I’m not concerned about TEF being able to meet its debt obligations in the short-term, but I am concerned about this company long-term and with this much debt on the books I just simply feel better looking at other opportunities to put my investment capital to work. The massive amount of debt puts constraints on its ability to pay out its huge dividend. The dividend policy, with this amount of debt on the books, is very aggressive and in my opinion shows lack of long-term vision and management. I view the large dividend as unsustainable long-term.

In the end, I should have never invested with TEF, as the poor fundamentals and extremely aggressive dividend policy do not, in my opinion, make it a stellar long-term investment. I was blinded by the huge yield, and I’m disappointed in myself for chasing yield as it goes against my investment thesis as a conservative, value-oriented dividend growth investor.

I learned a lesson here and paid for it out of my own pocket. The short-term capital loss I experienced as a result in the destruction of the share price was partially mitigated by the large dividend I received in 2011, as well as the fact that the loss offsets some of the short-term capital gains I received this year. I had over $3,000 in short-term capital gains for 2011, so I wanted to get TEF off my books and reduce some of those short-term gains, and consequently, my tax bill come 2012.

With the freed-up capital after the TEF sale, and a commission check I received this past week at work, I put that money (which totaled almost $5,000) to work for me in quality, long-term investments that I felt much better about. I’ll be discussing my recent purchases very soon!

I’ll update my Freedom Fund in early January to reflect the recent sale of TEF.

What about you? Getting rid of any underperformers before the end of the year?

Thanks for reading.

Edit: Corrected debt numbers.

Photo Credit: jannoon028

Comments

  1. says

    DM, We’ve all been here. I can tell you that I had been subscribed to a professional newsletter that recommended TEF based upon its yield and growth in emerging markets in wireless. Nevertheless, I passed even though they made a convincing case.

    This company is in the middle of the debt problems in Europe as you talked about. There’s no reason to go there unless the company is really strong and the market is getting it wrong, which is likely not the case with this one.

    sfi

  2. says

    SFI,

    There have been quite a few intriguing cases lately of why TEF makes an investment. These cases are all built around the fact that the stock is cheap, which it certainly is. But, why is it cheap? That’s what you have to ask yourself.

    Like Buffett says about investing in wonderful companies at fair prices, this is just one fair company at a wonderful price that I’m willing to pass on. If they had a debt load at about 1/2 the current size or less I’d be interested. With over $70mm in debt, however, I see more attractive fish in the sea.

    The emerging market operations, especially in Brazil, look promising and that was one of the main reasons I invested in TEF in the first place. But it just seems with recent missteps, and the extremely costly labor reduction I didn’t even mention in the article, they are moving in the wrong direction as a company…overall.

    You were smarter than I to pass on this one. I thought about sitting on it, because I do believe the share price will bounce back, but in the end it’s not the price you paid that matters. It’s whether it’s an attractive investment today or not, and I feel it is not. Plus, the capital loss helps with the taxes.

    Thanks for stopping by! Take care.

  3. says

    TEF’s interest coverage ratio is around 3.7 over the past 5 years. Anything above 1.5 is relatively safe. I don’t think the debt is much of a burden on the company since they generate enough to cover their debt interest expenses.

    I have companies such as CL, DE, CAT, PM, YUM, and IBM with debt to equity above 1. But that’s the way it’s always been. In a low interest environment, it’s perfectly normal for companies to have debt to fund such endeavors like expanding operations or share buybacks. They have enough operating income to cover the interest expense.

    But then again, debt can be a troublesome down the line. Take a look at AMR, they just went bankrupt.

  4. says

    Good post. I like your humble attitude. I have certainly done my fair share of investmentsmistakes. As my experience has grown they are getting fewer. I will continue to do wrong decisions occasionally. Whats important is that one have the objectivity to reconsider holdings and adjust to new fundamentals.

  5. says

    Henry,

    Thanks for stopping by. I appreciate your insights on that.

    I agree with you that certain companies can manage debt well and debt can be used to amplify returns…but it can also amplify losses.

    I think it really comes down to an individual’s risk profile and perhaps my risk profile is more conservative than yours. I like companies that manage shareholder’s money more conservatively and have a steady, long-term growth picture in place. Massive amounts of debt clouds that picture, in my view.

    TEF management has recently been discussing the debt load in light of the euro zone debt crisis and they are open to asset sales. All of the sudden, there is a lot of talk about the “dividend being safe”. It seems to me that a dividend is most unsafe right about the time management starts overly discussing how safe it is.

    In the end, you have to do what you’re comfortable with. If debt doesn’t bother you that much, then that really opens up a lot of investments for you. Debt does bother me (especially when I feel it’s not managed correctly), as I have a lack of it even in my personal life. No matter what, it’s important to stick with your investment thesis and ideals, and TEF falls outside those ideals.

    I would say my tobacco holdings are my general exceptions, as they have massive cash flows and low capital needs.

    Best wishes!

  6. says

    defensiven,

    I appreciate that. Thanks.

    I agree. It’s important to re-evaluate why you are holding a company and it’s always fair to ask yourself if you’re holding it for the right reasons. It’s important never to “fall in love” with a stock and always stay objective. I looked at TEF as objectively as I could, ignoring what I paid, and concluded that I do not find it an attractive investment even with the shares being so cheap. I find better companies in this sector, and that’s where I’ll put my capital to work (T, VOD).

    Thanks for stopping by!

  7. Anonymous says

    Hi Mantra,

    As you know, I think the TEF dividend isn’t sustainable. I believe you dis the right choice.

    Very truly,
    Manefla

  8. says

    Hey Mantra,

    The numbers are worse than you thought initially. Looking on yahoo finance, the long term debt (year ending 2010) is 72 BILLION not million, with current debts of 44 billion. All numbers listed are in thousands meaning add 000 to the end. I really doubt a company with a market cap of ~80B sitting on billions in cash would worry about a paltry $72M debt.

    I am with you on dumping TEF, I think T is safer.

  9. says

    Manefla,

    I agree with you here on the dividend. I think the stock price has been punished by not only the euro zone crisis and Spain’s individual problems, but also on fear that the dividend is not sustainable long-term.

    Thanks for the encouragement. You were long TEF at one point, correct? Are you still?

    Best wishes!

  10. says

    Stuart,

    Haha. Thanks for catching that. I knew the numbers, but somehow I typed them up incorrectly. I’m surprised that you were the first to catch that! Thanks again. I have edited the millions to billions and noted the edit at the bottom.

    I’m glad you’re with me on dumping TEF. I learned a little lesson on chasing yield for sure. Investing in a company with almost as much debt as it’s entire market capitalization is just not for me!

    Thanks again for catching my error! My brain was mush after writing two articles in a row apparently.

    Best wishes!

  11. says

    Hey Mantra,

    I really liked this post, becuase it’s a great reality check, and from the heart ;) Every investor makes mistakes along the way, it’s unavoidable ;) Any investor who says otherwise, or claims to be perfect isn’t being honest. I’ve made a few mistakes and will obviously make more… so don’t be to hard on yourself.

    I think selling this stock was a good move regardless of taking a loss! :) becuase you made a move to preserve your capital. I can assure you if you held onto this stock or averged-down you would have only lost more. High yield + high debt = disaster.

    When I first started reading your blog a few months ago I remember looking through your portfolio and noticed SA didn’t really fit into the profile. I knew at the time you were going for a higer yielding stock to increase your return.

    As you know I’ve done a lot of writing on our Canadian Income Trusts, which are similar types of high yielidng companies. I’ve learned as my readers have, that high yield = high risk. There is no way around it ;)

    Good move Mantra and you made the right decision! So don’t sweat it and top up the solid blue-chips – they are going to be on sale over the next month or so ;)

    All the best
    The Dividend Ninja

  12. says

    Manefla,

    Wow! I have basically stopped following TEF completely since offloading it. I’m EXTREMELY GLAD I got out when I did, and the cut simply confirmed what I had believed. It seems that when management starts clamoring about how safe a dividend is, that’s when you truly know how bad things are.

    I’m not surprised, but wow that cut came right after I sold. I guess I made that sell pretty timely.

    I’m glad you got out before I did. I chased yield until my lungs got tired, and then I asked myself why I was chasing. Great job realizing the company was in trouble.

    Thanks for sending me that link. I enjoyed reading that.

    Best wishes!

  13. says

    Ninja,

    Thanks for the encouragement. I always tell myself to never fall in love with a stock and try and stay objective. On this one, it’s not that I fell in love…it’s simply that I didn’t research as much as I should have. Shame on me. But, I got out pretty ok….and it looks like my timing couldn’t have been better considering the recent announcement of the dividend cut. Of course, long-term this is a good move for TEF as a company. They need to look at the long-term, instead of just throwing out cash like it’s going out of style.

    I can see the similarities with income trusts. Unfortunately, with a lot of high-yield high-risk plays your “high yield” ends up being a return of capital…which is a horrible situation to be in. Some of these mREIT’s seem to be the same way. High yield, but through a return of capital due to share price erosion.

    The best way to get high yield is to find the “accidental high-yielders”. Stocks that started out with a decent yield but due to overall market conditions or one bad quarter the share price drops enough to bring that yield up. Those are the times to strike.

    Thanks for stopping by. Always good to hear from the Ninja!

    Best wishes!

  14. says

    Mantra, Cheers!

    Yes share erosion (capital loss on share price) is a big key here, which results in the higher yield, isn’it it? Your timing was obviously impeciable – just in time!

    Kinda makes anyone wonder why high yield stocks are even worth it in the first place ;)

    I might also add you get the tax benefit of writing off this capital loss against any future capital gains (I’m sure you have virutally the same tax laws as we do in Canada). So there is an added benefit here…

    I still own three high yield stocks which were previous income-trusts. RSI.TSX, PGF.TSX, and LIQ.TSX. Rogers Sugar (RSI) I am hardly worried about, but I’ve been contemplating selling PGF and LIQ at a loss for year end. Unfortunately they are in registered accounts LOL ;)

    Cheers
    The Dividend Ninja

  15. Anonymous says

    Mantra-
    Thank you for your TEF post it helped push me over the edge to sell my position and replace it with VOD. It is refreshing to see someone say the made a mistake (helping me admit mine).
    Thanks

  16. says

    Ninja,

    Absolutely. Some of the high-risk higher yield stocks simply have a high yield through share erosion. If you’re tempted to find high yield, it most likely exists either in these types of securities (which are undesirable) or in REIT’s, MLP’s, or an “accidental high yielder” like I mentioned earlier. Sorting through them is the tough part, and usually it’s just better to stick to the tried and true like you say.

    The tax loss was one of the reasons I sold TEF. I had quite a bit of short-term capital gains this year and TEF will be my only short-term loss of the year and that helps next spring!

    Best of luck with your own selling decisions. Just part of the fun of investing, no?

    Best wishes!

  17. says

    Anonymous,

    Thanks! I’m glad that I helped you make that wise decision. Believe me, I was on the fence for about a month with my decision…and when I realized I was awake at night thinking about it…well, that’s when I realized it was time to sell and move on.

    Great move selling TEF and moving into VOD. Great company that is almost exclusively wireless, better management, low debt, great valuation, high yield and diversification across a few continents. What’s not to like?

    Best of luck with your new investment. I’m long VOD as well.

  18. Anonymous says

    DM

    You will probably think I’m an idiot for my actions, but I purchased TEF on Friday after it hit a new 52wk low. I established a position at a share price of 16.59. For the record, I agree with the risks you and everyone else have mentioned and considered them all while writing up my investment thesis for this stock, which was written the day before I purchased. I had been watching TEF for the past several months. I’m guessing it will take 2-3 yrs for my reasons for purchasing to play out. Let’s hope that this doesn’t turn out to be a contrarian idea that bites me in the ass.
    ExpatERE

  19. says

    ExpatERE,

    Hey! Thanks for stopping by.

    I don’t think you’re an idiot at all. Look, TEF as a company isn’t all bad. They provide a product/service that people need and they have great assets in emerging markets. If they can reduce their debt load significantly (which will probably require the dividend get cut further), they could be a fantastic company and investment long-term. Right now, it seems that they are at a crossroads, and due to what I feel is an unsustainable path I felt it was best to put my money to work in other areas. This path can be corrected and fixed, and at that point TEF would make a fantastic investment.

    The things going for you is that they are extremely cheap right now and due to that the yield is still very high. I purchased at the wrong time, and that’s my fault. If they get a hold on their operations this could be a very profitable investment for you, but do plan on this taking years.

    Best wishes with it!

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