Vodafone's growth promises look fanciful

Vodafone (VOD) optimistically says it is right-sizing “for growth”. A few weeks ago, it agreed to sell its Spanish business for up to €5bn (£4.35bn), following the disposals of its Vantage Towers, Hungary and Ghana businesses. However, the pessimists will say it is managing its decline.

The disposals coupled with adverse foreign exchange movements pushed down group revenue by 4.3 per cent in the six months to September. On an organic basis, and excluding Turkey which is going through a bout of hyperinflation, service revenue rose a modest 2.3 per cent.

One problem is the adjusted cash profit (Ebitda) margin, which dropped 0.8 percentage points to 29.1 per cent. Management believed this was acceptable because of significant energy costs. However, BT (BT.) managed to increase both its profitability and cash generation despite facing similar input cost pressures.

Margins will hopefully rise as its lay-off program is carried out. Of the 11,000 roles it plans to remove over the next three years it has scrapped 2,700 already. The difficulty is knowing where to cut back without damaging the business. It has highlighted the €150mn of investment in customer service as it doesn’t want to risk driving customers away with long phone wait times.

The bright spot was the return to growth in Vodafone's biggest market Germany, which accounts for almost a third of the business. In the second quarter revenue increased 1.1 per cent thanks to price rises pushing up average revenue per customers. However, this growth was purely from pricing, rather than increased volume, with low-single-digit customer churn in both broadband and TV.

If there is growth, it is unlikely to come from a big increase in the customer base. Instead, Vodafone will rely on margin expansion as the inflationary pressures recede, coupled with the proposed merger of Three UK with its UK mobile business. The UK was its second-fastest growing market, expanding 5.6 per cent and with more scale margins should improve further.

However, the deal still needs regulatory approval and without the merger the opportunities for growth are limited. Vodafone has managed to maintain the dividend and the Spanish disposal will give it enough cash to keep paying out for the foreseeable future. FactSet broker consensus expects the dividend to be held until 2027.

The 10 per cent dividend yield puts a cap on the downside, but until Vodafone can show any evidence of growth, this will continue to look like a managed decline rather than a right-sizing for growth. Hold.

Last IC View: Hold, 75p, 16 May 2023