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Vodafone primed for growth

The telecom giant's recovery is in full swing and it is time to be optimistic about its long-term prospects
September 14, 2017

Vodafone’s (VOD) investors have been a trusting bunch in the past few years. As the global telecoms market has shifted, the group has sold its cash-generative stake in US telecoms operator Verizon, overhauled the strategy and undergone a £19bn investment project. But now the veil of scepticism that had obscured the telecoms giant's performance has started to lift. The long period of spending is starting to bear fruit and with underlying revenue growth accelerating and the dividend looking more secure, we think investors would do well to top up their holdings.  

IC TIP: Buy at 213p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points

Returning revenue momentum

Improving outlook in India

High-yielding dividend

Decreasing leverage

Bear points

Data roaming cuts in Europe

Mobile spectrum spending

In the three months to June, Vodafone enjoyed a 2.2 per cent year-on-year increase in like-for-like service revenue – the highest quarterly uptick since early 2016. Making money from mobile, fixed-line and broadband contracts is far and away the biggest contributor to Vodafone’s top line and widely considered the best indicator of the group’s health. That’s why, following many years of falling organic service revenue, it is a relief that Vodafone has now reported 10 consecutive quarters of growth.

That first-quarter result included a 0.8 per cent service revenue rise in Europe, where all the group’s countries of operation reported a quarter-on-quarter improvement in revenue growth, excluding Germany. Across Europe, Vodafone has invested in fast mobile and broadband connections to give it the edge in an increasingly competitive marketplace. This helped broaden the mobile customer base in Germany and Spain, and increase average revenue per user in the UK and Italy.

The recent cut to data roaming charges is the thorn in the side of the Europe division. Vodafone’s management has pencilled in a €300m (£271m) revenue drag in the year to March 2018 due to the fact that they can no longer charge extra fees when European customers use data outside of their home country. More optimistic analysts suggest these cuts will be more damaging to the smaller telecoms providers, a possible silver linking for Vodafone.

Although Europe is far and away Vodafone’s biggest division (contributing nearly three-quarters of the top line in the first quarter), growth is fastest in the Asia, Midde East, Africa and Asia-Pacific region (AMAP). Here, a 7.9 per cent increase in like-for-like service numbers was driven by strong demand in South Africa’s Vodacom business. The positive market dynamics in this country recently encouraged management to up its stake in Vodacom to 70 per cent.

Meanwhile, broker JPMorgan is cautiously optimistic about a turnaround in India. Having suffered hugely since the arrival of low-priced competitor Reliance Jio, the division – which is due to be merged with fellow Indian telecoms operator Idea Cellular – is expected to return to revenue growth by the start of 2018. The reason, the broker explains, is that Reliance won’t be able to sustain in perpetuity its ultra-generous promotional discounts, which will help stabilise the market rate. Since Reliance’s launch in September 2016, the Indian wireless telecoms market has been consolidated from 11 players to seven, while data usage per person has risen.

The combination of Vodafone India – which contributed 12 per cent of the parent group’s total revenues in the year to March 2016 – and Idea, should help to ease the group’s crippling debt. Close to €8bn of borrowings have been stripped out of the parent company’s balance sheet and, although the new entity’s leverage is forecast to hit 5.6 times in March 2018, this is expected to fall quickly thanks to capital expenditure synergies and necessary sales.

Stripping out the capital expenditure requirements of India – which have been hefty in recent years due to investment in mobile data coverage – could well be important as Vodafone approaches a crucial auction for mobile spectrum in the UK. Before the end of the year, the UK’s telecoms regulator, Ofcom, will auction licences to use 190MHz spectrum for 4G and 5G mobile data coverage. Vodafone is expected to be a big bidder, having spent close to £800m last time spectrum became available in the UK. Although this extra expenditure is likely to dent Vodafone’s free cash flows in the current financial year, claiming extensive 4G and 5G coverage will help increase customer numbers, revenue and profit in the long run.

VODAFONE (VOD)   
ORD PRICE:213.3pMARKET VALUE:£58.3bn
TOUCH:213.3-213.4p12-MONTH HIGH:234pLOW: 187p
FORWARD DIVIDEND YIELD:6.6%FORWARD PE RATIO:20
NET ASSET VALUE:264ȼ*NET DEBT:42%
Year to 31 MarTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201542.22.22611.2
 Turnover (€bn)Pre-tax profit (€bn)Earnings per share (ȼ)Dividend per share (ȼ)
201649.82.90714.5
201747.63.27814.8
2018*45.93.641015.1
2019*46.34.331215.4
% change+1+19+20+2
Normal market size:10,000   
Matched bargain trading    
Beta:0.84   
*Includes intangible assets of €46.2bn, or 169ȼ a share
**JPMorgan forecasts for turnover, adjusted PBT and EPS, Jefferies for DPS £1=€1.10