Interactive Investor

Stockwatch: can Vodafone shares really recover from this 20-year low?

6th December 2022 10:30

Edmond Jackson from interactive investor

There’s plenty wrong with this FTSE 100 favourite, but there are also good reasons for contrarian investors to re-evaluate the investment case, believes analyst Edmond Jackson.

News of how the CEO of four years will soon leave Vodafone Group (LSE:VOD) prompted a 2p initial rise in its FTSE 100 stock to 93p, such is the standard reaction to the idea of a new boss when fresh ideas and action are required. 

If the business is strong enough, such a rise is usually sustained longer than the first hour of trading, but Vodafone soon fell back to 91p – a chart low as far back as long-term data will trace.  

I suspect this was due to the extent of telecoms competition nowadays, but also Vodafone’s €68.5 billion (£59.0 billion) net debt as of end-September, where the service cost took 41% of interim net profit – reflecting a period when interest rates only started to rise. 

Vodafone shares are down 34% this year, but BT Group (LSE:BT.A)’s fall is 38%. September net gearing was 119% and 111% respectively. 

The “fear” side of the equation is Vodafone having sprawled itself too far internationally; that a stagflation environment will be a hurdle to slimming its operations. Yet stock prices are liable to overshoot when established as a momentum trade, up or down, hence on a “greed” view this all-time low combining with a new CEO merits attention. 

Has the stock fallen to a level that offers value? 

If consensus for earnings per share (EPS) of 10.6 euro cents in the current financial year to 31 March (flat thereafter) is fair, the equivalent 9.1p implies a forward price/earnings (PE) ratio of 10x. This would represent 35% annual growth, seemingly rich just as international interest rate hikes impact economies. Interim results nearly a month ago did show adjusted basic EPS up 22% after a 12% rise in operating profit, although revenue edged up only 2%.  

The operating margin did thus commendably rise from 11.7% to 12.8% in context of a €1 billion cost-cutting plan, but amid higher industry costs and tough competition I would not expect this to keep rescuing slight revenue advances (or falls). 

On the dividend, consensus for 7.8p a share equivalent implies an 8.7% prospective yield but with hardly 1.2x cover the market does not take this seriously.  

Vodafone has presumably guided for such a pay-out, representing a 2% advance on the March 2022 financial year. The company is also vigorously buying back its shares rather than reducing its debt which rose 8% year-on-year to September. In my view, a new CEO should re-prioritise. 

The asset base offers intrigue, however. Despite €68.5 billion net debt, end-September net assets were €57.7 billion, or £49.2 billion, which implies 180p per share – hence 90p in the market representing a 50% discount.  

Intangibles unfortunately constitute 90% of that net asset value (NAV) yet are a similar 88% of BT’s 160p NAV per share, hence its market price of 121p being a 24% discount.  

I don’t dismiss the relevance of intangibles, given they represent accumulated premiums paid to book value when making acquisitions over many years. Otherwise, managers overpaid. I respect that conservative investors will be wary though. 

Vodafone - financial summary
Year end 31 Mar

 2016201720182019202020212022
Revenue (€ million)49,81047,63146,57143,66644,97443,80945,580
Operating margin (%)2.77.89.2-2.29.111.612.4
Operating profit (€m)1,3203,7254,299-9514,0995,0975,664
Net profit (€m)-5,405-6,2972,439-8,020-9201122,088
Reported EPS (euro cents)-20.3-7.815.8-16.2-3.10.47.2
Normalised EPS (cents)-18.0-9.816.3-6.7-7.92.77.8
Ops cashflow/share (cents)53.750.848.847.059.158.062.1
Capex/share (cents)52.031.729.329.525.829.131.1
Free cashflow/share (cents)1.719.219.517.533.228.931.0
Dividend/share (cents)14.414.815.19.28.99.29.0
Earnings cover (x)-1.4-0.51.1-1.8-0.40.00.8
Return on capital (%)1.03.34.0-0.83.04.04.7
Cash (€m)18,25914,95513,46926,64920,64614,98015,427
Net debt (€m)38,79331,31429,51226,30654,27952,78054,665
Net asset value (€m)83,32572,20067,64062,21861,41055,80454,687
Net asset value/share (cents)314271254228229198193

Source: historic company REFS and company accounts

Analysts at Numis estimate Vodafone’s German, Italian and UK operations are worth over €47 billion; that divesting Spain, smaller European markets plus Egypt/Turkey could raise €17 billion; and selling a two-thirds stake in South Africa-listed Vodacom, another €11 billion. Those operations alone could therefore represent a 30% premium to net assets.  

I would treat such numbers with a pinch of salt as they are hypothetical, not what might be realised in sales – where prices paid would reflect the value acquirers believe they can gain by combining with their own operations. 

Yet it hints that the “break-up, sum-of-parts” story may re-invigorate around Vodafone – especially if activist hedge funds do their own sums and lobby a new CEO. 

An established target for activist investors 

Early this year, when Vodafone traded around 120p, there was news of Cevian Capital, a Swedish hedge fund, building a position – allegedly to become one of the tenth-largest shareholders. It never reached the 3% disclosure level, although that could have been an over-commitment for a single fund in a (now) £25 billion company.  

By mid-year, Cevian had reportedly sold most of its position, but which might have reflected realism about industry conditions than a final verdict on slimming down Vodafone. 

Coast Capital, a New York-based fund that “takes a private equity approach to investing in public markets...and actively works with companies to create and release value” also bought in early this year. It is best-known in the UK for activism towards FirstGroup (LSE:FGP), the transport operator, where it challenged plans to sell US assets.  

My concern is FirstGroup having a similarly weak, long-term chart – i.e. is shareholder activism enough to turn around businesses that are fundamentally challenged? French billionaire Patrick Drahi accumulated 18% of BT last year but looks underwater.     

More recently in September, another French billionaire, Xavier Niel, bought 2.5% of Vodafone arguing: “opportunities exist to accelerate...the streaming of Vodafone’s footprint and the separation of its infrastructure assets”, besides improve profitability.  

Creation of a vacancy at the top is an invitation to such activists, with smaller speculators attracted to follow.   

As dependent on Openreach as any UK operator 

This I find is relevant to revenue growth – at least for fibre to the premises (FTTP) expansion, on which many telecom operators appear to be pinning hopes. 

A plethora of offers – such as Black Friday recently – have bumped up demand for installations just when BT has declared another £500 million spending cuts. Supposedly, Openreach will hire over 2,500 engineers over the next year, but whether it has been strikes lately or a decision at the top, FTTP now seems quite a chaos. 

I find myself hardly alone as a BT customer: accepting a free upgrade to FTTP last September (and where does that leave revenue growth if others follow BT?) that has stalled. Two installation dates were missed and the matter thrice pushed forward for reviews. 

Yes, Vodafone is Britain’s largest FTTP operator but in terms of new connections its promoted £26 monthly charge is not competitive versus BT or, for example, Sky at £12. 

With Openreach facing higher costs and apparent work overload, it begs the question for BT shareholders, the extent they are picking up the tab for this FTTP race between rivals. There are also increasingly questions over 5G, another plank for growth, due to its allegedly using twice the energy demands of 4G. 

I digress slightly but Vodafone UK is dependent on Openreach in key respects, hence a need to appreciate what is happening there. 

A speculative case to start averaging in 

With the stock easing to 90p after a weak US stock market close, it breaks chart rules to consider buying Vodafone. 

A sense of intrinsic value is speculative given earnings and dividend projections look rosy, relative to the likelihood of a 2023 global recession.  

Genuine contrarian investing means having reasons to buck prevailing sentiment, which in Vodafone’s case implies waiting for an accomplished CEO to declare his or her agenda.  

The dilemma is the stock likely having jumped by that time, hence a case, according to your risk appetite, for reasoning the asset base already looks ripe for streamlining – and realising cash, to help cut debt. In which case: Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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