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Vodafone - Robust underlying numbers

George Salmon | 13 November 2018 | A A A
Vodafone - Robust underlying numbers

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Vodafone Group plc USD0.20 20/21

Sell: 112.08 | Buy: 112.14 | Change 2.78 (2.54%)
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Adverse foreign exchange moments and impairments of EUR 3.5bn in Spain, Romania and India meant Vodafone delivered an adjusted half year operating loss of EUR 1.4bn.

However, underlying numbers are more robust. For example, lower operating costs helped organic earnings before interest, tax, depreciation and amortisation (EBITDA) rise 2.9% to EUR 7.1bn, slightly ahead of consensus forecasts.

The shares rose 6.6% on the news.

The interim dividend was held flat at 4.84 eurocents per share.

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Our view

Vodafone used to be more about the growth potential of India and emerging markets than its European operations.

Recent deals, to buy Central and Eastern European assets from Liberty Global and deconsolidate the Indian business, change all that. The Liberty deal is Vodafone's biggest for 18 years, and, should it go through, would mean Europe becomes responsible for over three quarters of group profits.

As well as shifting geographic focus, the deal has potential to help Vodafone address a couple of issues that have plagued the group.

The first is the significant fixed costs of running a telecoms business. The cost of infrastructure and mobile spectrum is huge. Vodafone says the extra scale Liberty brings means EUR535m a year in operating and capital expenditures savings are possible within 5 years of the deal completing.

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. Customers often just go 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 through the Liberty deal 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. The risks associated with that can't be ignored, especially since net debt will tick up towards the top end of the group's target range.

That has implications for the dividend. A sale of Vodafone's Towers business could ease the debt burden, but the group will need to prioritise restoring order to its balance sheet over significant dividend increases.

Despite the lack of meaningful growth potential, the prospective yield of 8.8% will likely turn heads. But investors should remember Vodafone's free cash flow hasn't always covered the dividend. That's not sustainable in the longer-term, and there's no guarantee the Liberty deal will solve the problem.

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Half Year Results (excluding the impact of accounting changes)

Organic service revenue rose 0.5% in Q2, and 0.8% in the half - to EUR 19.7bn.

In Europe, organic service revenue declined 1.8% to EUR 15.1bn, as growth in Germany was offset by increased competition in Italy and Spain. European consumer adjusted EBITDA fell 4.2% to EUR 5.4bn.

In the Africa, Middle East and Asia Pacific (AMAP) region, foreign exchange movements and disposals impacted results, but on an underlying organic basis service revenue rose 7.4% to EUR 4.4bn, with EBITDA rising 6.8% to EUR 1.7bn. Turkey and Egypt were among the stronger-performing regions.

Net debt was EUR 32.1bn compared to EUR 29.6bn as at the year-end in March. The increase was driven by slightly higher capital expenditure of EUR 2.9bn, spectrum purchases of EUR 1bn and a net cash outflow in relation to the Vodafone Idea transaction of EUR 800m.

Looking ahead, CEO Nick Read is reviewing the future of its European tower operations, and has set out longer-term targets to simplify the business' structure. He hopes the changes can deliver 'revenue growth, reduce churn and lower our European net operating expenses by at least EUR 1.2bn by 2021'.

He's also updated full year guidance. Underlying organic adjusted EBITDA growth is now 3% (previously 1-5%) and pre-spectrum free cash flow is now expected to be EUR5.4bn, (from '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. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.