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Vodafone - muddling through

Sophie Lund-Yates, Equity Analyst | 5 February 2020 | A A A
Vodafone - muddling through

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Vodafone Group plc USD0.20 20/21

Sell: 134.14 | Buy: 134.22 | Change 0.08 (0.06%)
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Vodafone's third quarter organic service revenue grew 0.8%, to EUR9.7bn. That reflects a strong performance in the Rest of World division offsetting weakness in Europe.

The group reiterated full year guidance of underlying cash profits of EUR14.8bn to EUR15.0bn, and free cash flow before spectrum costs of EUR5.4bn.

The shares rose 1.5% following the announcement.

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Our view

Vodafone, and telecoms generally, have some exciting opportunities ahead with the roll out of 5G. However, competition remains intense, capital expenditure eye watering, and spectrum auctions continue to cost more than expected, putting pressure on cash flows.

Vodafone's debt pile has recently reached EUR48.1bn, thanks primarily to the recent acquisition of Liberty Global assets in Europe. The planned sale of some of the group's European tower assets will help reduce the debt burden, as will the sale of its 55% stake in Vodafone Egypt. The group is targeting the lower end of its 2.5-3.0x net debt to cash profits range in the next few years.

Still, the tower sale will mean the group's losing an attractive asset. Mobile providers pay tower owners rent, which generates a steady return.

Against that hostile background, the bull case for Vodafone has long been based on an attractive dividend. However, a 40% dividend cut last year means the stock now offers a prospective yield of 5.3%, not that far ahead of the FTSE 100's 4.5% historical yield. The question now is whether the sharper consumer focus can help the group grow shareholder returns over time.

The savings to be had from the Liberty deal should help. Vodafone reckons it can get EUR535m a year in operating and capital expenditure savings within 5 years of completion.

The acquired Liberty businesses also create more cross-selling opportunities. Vodafone's long been focused on rolling out broadband, fixed line and TV services across its European markets. It's finding that customer retention is significantly better among those taking up multiple products.

The group's also launched a series of speed-tiered unlimited data plans, as it looks to offer customers something different. The initiative's showing early signs of success in some markets, but ultimately there isn't much preventing competitors from copying it if it proves to be a winner.

That's the industry's biggest challenge. Despite the multi-billion investments in mobile spectrum, there's not much differentiating mobile providers other than the price they charge. Customers often just go with the cheapest deal, which Vodafone has found out to its detriment in India and Spain.

All-in-all then, while we think the portfolio changes and strategy make some sense, there's no guarantee the group can thrive from here.

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Third quarter results

In Europe organic service revenue (OSR), which excludes the contribution from the acquired Liberty Global assets, fell 1.4% to EUR7.6bn.

German OSR was flat at EUR2.9bn, as solid retail growth was offset by a decline in wholesale. In the UK OSR grew 0.6% to EUR1.3bn, as wholesale trends were weak here too, and international call rate regulation hurt revenue growth. In Italy OSR fell 5% to EUR1.2bn, primarily because of price increases in previous years, although competition also remains "intense". In Spain OSR fell 6.5% to EUR1.0bn.

In the Rest of the World OSR rose 9.1% to EUR2.1bn. In South Africa, service revenue increased 4.6%, and growth remained strong in DRC and Mozambique. In Turkey OSR rose 17.3%, although this was slower than the 19.8% growth seen in the previous quarter, reflecting last year's price hikes.

Vodafone has made a preliminary agreement to sell its 55% stake in Vodafone Egypt to Saudi Telecom Company for EUR2.2bn, or 11.2x adjusted operating free cash flow. If all goes well the deal should complete by the end of June this year. Vodafone also agreed to sell Vodafone Malta for EUR250m, subject to regulatory approval.

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