Telefonos de Mexico, S.A. (ADR) (TMX)

Telmex Downgraded to a Sell

Posted Wed Feb 13, 01:34 pm ET

We are changing our recommendation on Telefonos de Mexico or Telmex (TMX) from Hold to Sell. Fourth quarter 2007 results were lower than expected, and Mexican domestic growth has stalled. Expansion in other Latin American regions, particularly Brazil, is expected to continue in the near future.

Meanwhile, the company still needs to increase the profit margins of its acquired units, which are currently well below that of its Mexican business. Its valuation seems excessive if compared to other Latin American operators, and the difficult economic environment in the U.S. is a source of concern.

TMX is trading at 10x our 2008 earnings estimate, which represents a significant discount to the forward P/E ratio for the S&P 500 and the industry average. TMX’s P/E discount mainly reflects slow projected growth for the Mexican local phone business as well as uncertainty surrounding the impact of recent acquisitions to further expand in Latin America, and the uncertain business environment is some Latin American countries.

However, if we consider the EV/2007 EBITDA valuation, the stock does not seem to be undervalued at all. Its price/sales ratio is also well above the industry mean. Indeed, we continue to have a positive outlook for Latin American economic growth, but the difficult economic environment in the U.S. should have a negative impact on Mexico in the very short-term, and the company is still highly dependent on its Mexican performance.

All considered we are changing our current recommendation on TMX from Hold to Sell. Our six-month target price is US$30 per ADR is based on EV/2007 EBITDA of 5.5x, closer to the valuation of other Latin American telecom operators.

Read the full analyst report on TMX.
http://register.zacks.com/ucd/step1.php?ALERT=FOOL_ZER&d_alert=ZER_CONF&t=tmx&ADID=FOOL_ZERFEED