Portugal may be out of the headlines today, having ceded its place as the eurozone’s “crisis du jour” to Greece or Spain (depending on the day.) Nonetheless, economists and investors have documented and continue to monitor the nation’s economic woes: it has a high debt load, as have so many other countries on the eurozone periphery, and remains at risk of default. So it’s not surprising that Portugal Telecom (PTC.LS), the country’s leading provider of telecom services, is struggling as well, despite its 26% stake in Oi Telecommunications of Brazil, the largest company of its kind in a relatively fast-growing emerging market. While Portuguese GDP has been shrinking since 2008 (see the brown line on the chart below), Brazil’s economy has been expanding; when the two telecom companies finalized Portugal Telecom’s investment in 2010, Brazil’s GDP was growing at a 5% clip. Even now that it has slowed to 2%, that still beats Portugal’s economic performance, as the latter economy continues to contract.
At the heart of Portugal’s economic weakness is a weakness in the ability and willingness of the country’s consumers to spend. That has taken a toll on Portugal Telecom’s power to generate earnings – and its StarMine Earnings Quality (EQ) model score of 13 signals that those earnings may not be sustainable over the coming quarters. For a company like Portugal Telecom that has a hefty debt load and must make sizeable interest payments on that debt, that could be seen as a worrying sign.
StarMine uses computer-driven models to analyze the financial statements of thousands of publicly-traded companies, and to calculate a proprietary StarMine Earnings Quality (EQ) scores for each of those businesses. The companies that record the lowest StarMine EQ scores are those that are least likely to be able to sustain their past earnings track record. (For a more detailed explanation of this model, please refer back to this recent article about the earnings quality of American Express.) This examination of Portugal Telecom’s earnings is the next installment in a series of articles looking at the earnings quality of companies across Europe that score either notably low when measured by this quantitative model.
The chart below shows Portugal Telecom’s net income for the quarter ended December 2011, broken up into its main components. The company’s €90 million in operating income was dwarfed by its interest expenses of €219 million; not surprisingly, the latter represented the largest drag on net income. Even factoring in Portugal Telecom’s “other income” — consisting mostly of its share of Oi Telecommunications’ profits – wasn’t enough for Portugal Telecom to cover those recurring interest expenses. To finance its purchase of the stake in Oi, Portugal Telecom had to take on additional debt and today its short-term debt stands at €3.2 billion, €2 billion more than it had a year ago, at the time the investment was completed. Its long-term debt, meanwhile, has risen by €2.6 billion to €9 billion in the same period. That rising debt load will only translate into still higher interest payments, as the tight lending environment for Portuguese companies drives borrowing costs steadily higher.
Portugal Telecom can manage those interest payments as long as the company’s revenues are increasing and its margins are expanding. Unfortunately, that doesn’t seem to be the case. The chart on the right, below, shows that Portugal Telecom’s trailing four-quarter operating profit margin (represented by the blue line) has been falling since 2007, and falling faster than the industry median (represented by the gold line). Back in 2007, the company’s operating profit margin was actually higher than the median for its European peers, but today it stands at only 13%, more than four percentage points below the industry median. To compound the problem, the company’s revenues have fallen steadily in the past three quarters. Lower revenues and lower margins usually lead to lower earnings.
The chart on the left, below, shows the company’s return on net operating assets, a measure of the company’s operating efficiency. Again, the company has seen the return on its net operating assets decline since 2008, to a level that is 9 percentage points below the industry median of 15%. That means the company isn’t using its assets as efficiently as its competitors in the region, another poor sign for future earnings.
Portugal Telecom’s Brazilian investment may be a boon for the company’s revenues and profits in the longer haul, but in the short term, it seems clear that poor economic conditions in its domestic market are going to dominate the company’s prospects. To the extent that Portugal Telecom’s business and retail customers opt for more bare bones telecommunications service plans that cost less, that will create even more of a drag on the company’s earnings. The high debt levels at Portugal Telecom mirror the high debt levels of Portugal as a whole; similarly, as the nation struggles to regain its competitiveness and begin to grow again, Portugal Telecom will be doing the same. Portugal Telecom’s role as a microcosm of the country’s economy appears to be largely responsible for its low StarMine EQ score, and the reason why its earnings appear to be unsustainable in 2012.
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