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Vodafone - Italy and Spain weak, but Germany and Africa good

George Salmon | 25 July 2018 | A A A
Vodafone - Italy and Spain weak, but Germany and Africa good

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Vodafone Group plc USD0.20 20/21

Sell: 127.26 | Buy: 127.30 | Change -0.58 (-0.45%)
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While growth in organic service revenue has slowed, Vodafone's first quarter results are broadly as expected, with emerging market growth offsetting weakness in Italy and Spain.

The shares were little moved on the news.

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Our view

It wasn't so long ago that the investment case at Vodafone was more about capitalising on the growth potential of India and emerging markets than the European operation.

The Liberty deal, which comes hot on the heels of the decision to deconsolidate the Indian business, changes all that. Should it go through, it'll be Vodafone's biggest for 18 years. It'll also mean 77% of group profits will be generated in Europe.

As well as shifting geographic focus, the deal has potential to help Vodafone in dealing with a couple of long-standing issues.

The first is the significant fixed costs of running a telecoms business. The cost of infrastructure and mobile spectrum is huge. For Vodafone, the result has been that free cash flow hasn't always covered the dividend.

The Liberty deal will bring greater scale, which has clear benefits. Vodafone reckons it can generate EUR535m per year in operating and capital expenditures savings within 5 years of the deal going through.

The second problem is that despite all the investment in the upkeep of the network, there's not much differentiating providers other than the price they charge, and so little to stop customers going with the cheapest deal. This problem was most recently illustrated in India, where a new rival undercut the group, leading to billions in write-downs.

To counter the lack of pricing power, Vodafone's been rolling out broadband, fixed line and TV services across its European markets to sit alongside its existing mobile offer. Early indications are that the tactic is working, and customer retention is significantly better among customers taking up multiple products. Adding millions of extra broadband customers opens the door to even more cross-selling opportunities too.

The group expects the cost of integrating the two businesses to be around EUR1.2bn. That means the risks can't be ignored, especially since net debt will tick up towards the top end of the group's target range.

Nonetheless, the dividend policy remains unchanged. Vodafone plans to increase the payout each year. The prospective yield of 7.3% is attractive, but only has value if the group can generate the cash to back up the promises.

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First Quarter trading details

Vodafone has reported quarterly revenue of EUR10.9bn, down 4.9% on the prior year. However, this comparison is weakened by a change in accounting method and adverse foreign exchange movements. On an organic basis, service revenue rose 0.3%.

Service revenue in Europe was EUR 7.5bn. On an organic basis, this represents a drop of 1.3%, reversing the improving trend of last year. While more mobile and broadband customers helped Germany delivered continued growth, organic service revenue in both Italy and Spain slipped into the red. Both countries are seeing higher levels of competition. The UK's underlying performance improved, but changes to mobile handset financing meant organic service revenue still fell 4.9%.

Within Africa, Middle East and Asia-Pacific (AMAP), organic service revenue rose 7%, but currency headwinds saw reported revenue drop 6% to EUR2.2bn. Vodacom, the group's South Africa- focused business, saw organic growth of 5.1%, while strong growth in Turkey and Egypt ensured the rest of AMAP delivered organic growth of 9.4%.

In India, ongoing competitive pressure and lower fees for connecting calls led organic service revenue down 22.3% to EUR955m. The merger of Vodafone India and Idea Cellular is expected to complete in August.

The group still expects to see growth in organic adjusted EBITDA of 1-5%, with free cash flow (before accounting for the cost of acquiring mobile spectrum) of at least EUR5.2bn.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.