Vodafone cuts cash flow guidance

Vodafone (VOD) has downgraded its profit and cash flow guidance as rising inflation bites. Falling profit in Germany and Italy coupled with increased costs contributed to a large cash outflow in the first half. The board is now planning to slash more costs.

The underperformance of Germany, its largest and highest margin market, was a big contributor to the 2.6 per cent drop in adjusted cash profit. Vodafone's German broadband customer base declined by 83,000 because a new telecoms regulation made it easier for customers to get out of contracts.

The decline in higher margin broadband customers, in addition to rising customer acquisition costs, pushed down adjusted cash profit by 7.4 per cent as the profit margin dropped 4.3 percentage points to 40.6 per cent. Italy also saw a 17 per cent drop in adjusted cash profit because of increased competition in mobile and a €105mn (£91.3mn) legal settlement.

The only market to perform well was the UK, which, as the lowest margin locale in Europe, was previously seen as a weakness. Mobile service revenue rose 10.5 per cent and 76,000 contract customers were added during the period. Despite price rises, contract churn remained stable which suggests a degree of pricing power. If Vodafone's deal with Three UK goes through, the combined company would be the largest domestic mobile operator and put it in a position to profit from economies of scale around 5G.

Despite the performance of the UK, the cash position worsened. Free cash outflow rose from €1bn to €3.2bn. This was because of the drop in profit and a rise in licence and spectrum costs, which jumped to €2.2bn from €482mn last year. Net debt increased by 2.8 per cent and supporting this heavy burden will become increasingly more difficult should interest rates continue to rise.

To tackle this cash issue, chief executive Nick Read has promised a “a new cost savings target of €1bn-plus focused on streamlining and further simplifying the group”. The aim is to achieve this by 2026 through several joint ventures (JV). It has entered one with Altice on the delivery of broadband to 7mn homes and another with GIP and KKR for Vantage Towers.

Forward PE is falling and is now just 10 times – which looks an attractive valuation given the forward free cash flow yield of 14 per cent. However, patience with Vodafone turning things around is running out. Activist investor Cevian has already slashed its stake in the business, having only taken a position at the beginning of 2022. Economic conditions can effect anyone, but the German exodus is a particular cause for concern, we move to Hold.

Last IC View: Buy, 120p, 17 May 2022