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Don’t Diss This High-Yielding Israeli Stock

 November 10, 2011 10:28 AM

When will politicians learn to keep their traps shut when they're mic'd up?

The latest gaffe comes compliments of French President, Nicolas Sarkozy, and our very own President Obama. Turns out that neither man considers Israeli Prime Minister, Benjamin Netanyahu, their BFF.

While they might have a beef with Israel's leader, it doesn't sour my appetite for Israeli stocks one bit. Political tension or not, the country is home to one of the most undervalued dividend-paying stocks I know of – Cellcom Israel (NYSE: CEL).

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If your long-term investing goals include generating income and modest capital appreciation, I suggest you consider adding some shares to your portfolio. Here's why…

Dialing Up Dividends in the Middle East

Cellcom is the largest wireless provider in Israel, with 3.4 million subscribers and about 33% marketshare. In other words, it's an international blue-chip stock. And it boasts compelling fundamentals, including:

~Steady demand and steady cash flow. To say Israel embraces cellphones is an understatement. Penetration rates top 100%, which means many people own more than one phone. While this limits subscriber growth, it creates an opportunity for a well-managed company like Cellcom to generate fistfuls of cash by providing such a vital service to Israelis. And it does. In the last two quarters, Cellcom generated over $150 million in free cash flow.

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~Favorable demographics. Israel's overrun with young people, who tend to be more receptive to new technologies. The median age is 29.4 years compared to 36.9 years in the United States. This plays right into the company's growth strategy of providing value-added data services.

~Growth opportunities. Revenue from data services – the fastest-growing segment for all wireless providers – should contribute to steady, overall increases in sales. In the most recent quarter, data and service revenue increased a solid 5.2% and now account for 25% of overall sales.

~Dollar hedge. By investing in a foreign dividend-paying stock, we get an automatic raise (and potentially a hefty one) should the U.S. dollar really take it on the chin.

The Two Most Compelling Reasons to Buy

An investment in Cellcom does carry some risks, namely regulatory and execution risk. The government is trying to encourage more competition by implementing number portability. And Cellcom is getting a new CEO in January. But I'm convinced the stock's current valuation and yield outweigh these risks. Right now, Cellcom trades at an extremely undervalued price, with a price-to-earnings ratio of just 6.53. That's equal to about a 50% discount to U.S. telecoms like AT&T (NYSE: T) and Verizon (NYSE: VZ) and British telecom, Vodafone (Nasdaq: VOD).

The upside to the company's depressed stock price is, of course, a higher yield. At current prices, Cellcom sports an attractive 9.9% dividend yield.

It's true that the dividend is subject to a foreign withholding tax of 20%. However, U.S. tax law allows us to take a credit or deduction for such withholdings. (Please, check with your tax advisor to determine which option makes most sense for you.) Even after we factor in the withholding, shares still yield over 7%, more than enough to justify the trip overseas.

Bottom Line: Cellcom reports third-quarter results after the market closes on Tuesday, making now perhaps the last time to pick up shares at these levels. Institutions have been net buyers over the past three months. It might be time for us to join them.

Ahead of the tape,

Louis Basenese



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