Vodafone Group plc (VOD) USD0.20 20/21

Vodafone has confirmed the sale of its Italian business to Swisscom for €8bn in cash, subject to approvals. The deal values the Italian business at 7.6 times its expected underlying cash profit (EBITDAaL), a premium to the wider group’s current valuation.

With sales now agreed on both its Italian and Spanish divisions (previously announced), Vodafone has reviewed its capital allocation policy.

There’s no change to guidance for the current financial year, ending 31 March, with underlying cash profit and underlying free cash flow expected around €13.3bn and €3.3bn respectively.

Total dividends for the current year are expected to remain at 9.0c per share but then reduce to 4.5c per share from the new financial year, with an aim to grow from that base. There are also plans to return up to €2bn following the completion of each sale, a maximum of €4bn when both are complete.

The shares rose 3.5% in early trading.

Our view

Vodafone's third quarter had some pockets of optimism for investors to cling to. Growth was in line with the second quarter, arguably a better result than some had feared. But the wider issues associated with recent lacklustre performance remain.

Sales in the telecom sector should be relatively robust, as broadband and mobile services are hardly optional. Yet, over the last ten years, telecom giants have had to pump huge sums of cash into building out fibre networks and snapping up parts of the 5G spectrum. The main challenge has been the low sales growth relative to spending when you look at telecoms compared to other sectors.

Vodafone's also been underperforming versus its peers. Service revenue growth and customer satisfaction in key areas like Germany, Italy and Spain have struggled to keep pace.

In response, Vodafone has an evolved strategy. There are job cuts, the proposed merger of its UK business with Three UK, and the recently agreed sale of the underperforming Spanish and Italian divisions.

We welcome the change, but there's a lot to do.

The key market of Germany is a perfect example of the challenges at hand. After more than €20bn of investment, growing service revenue and customer numbers is proving a challenge. Vodafone was slow to adapt to changing regulations, and when it did, introduced a poor customer experience. There are further regulatory changes coming over this year which mean Vodafone needs to recontract over 8.5mn customers (c. €800mn in revenue).

Outside Europe, the Vodacom subsidiary has some exciting growth opportunities in Africa and is targeting mid-to-high single-digit cash profit growth over the next few years. Africa could become increasingly important as the region develops, and Vodafone's leading position in several markets means it's well-positioned to benefit.

Net debt rose to €36.2bn over the first half, which is a little lofty for our liking. And while operating cash flow is stable, cash demands remain high. With the Spanish and Italian sales now confirmed, subject to approvals, we’ve got new information on capital plans.

With around $12bn coming in, $4bn is pencilled for buybacks. We can only assume a decent chunk of the remainder will go on reducing debt. Key for shareholders will be the reduced dividend from next year on. At half the current level this will be a hit to income investors, but still represents a forward yield of around 5.5% based on current prices. Rebasing is a good move in our eyes. Nothing is guaranteed.

All-in-all then, while we think the portfolio changes and new strategy make sense, the fundamental challenges that go with being a telecom remain. And with growth hard to come by, we'll need to see sustained positive progress before getting too excited.

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