Vodafone beginning to ring the changes

Up until now, progress had been slow at Vodafone Group (LSE:VOD) and this fiercely competitive sector is unforgiving. The second-quarter performance showed a return to growth in its troubled German operation, while Africa continues to grow apace and the UK was buoyed by a quick start to the integration of Three UK. Nonetheless, while those signs are positive, a sustained trend will need to be shown before investors can justifiably buy in to the recovery.

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At the headline level, the numbers were mostly positive for the half-year, with revenues of €19.6 billion representing an increase of 7.3%, slightly shy of expectations. Adjusted earnings grew by 5.9% in the six months ended 30 September to €5.7 billion, ahead of the expected €5.62 billion, although operating profit fell by 9.2% to €2.2 billion, largely due to the depreciation effects of the Three UK merger. Service revenue for the half increased by a promising 8.1% to €16.3 billion, or by 5.7% on an organic basis, ahead of the 4.8% expected.

In terms of strategy, the group had quite simply been fighting fires on too many fronts while dealing with an increasingly onerous debt burden, leading to the need for a significant transformation. What is now emerging is a smaller and less geographically diverse, but more focused operation.

Asset sales in Italy and Spain, as well as a reduction of its stake in Vantage Towers were reflected by cash proceeds of €13.3 billion over the previous year, which reduced net debt to €22.4 billion from a previous €33.2 billion, although this has spiked again to €25.9 billion and remains an ominous weight on the group.

Despite some progress over the last quarter, the most obvious thorn in Vodafone’s size remains the German operation, which is the group’s largest and accounts for 31% of total revenue, which declined by 2% over the half. The unit is hoping finally to shake off the effects of customer losses which were largely attributable to enforced price increases last year, competitive activity elsewhere and the lingering effects of the change to German TV law which resulted in a recontracting of customers.

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More promisingly, the UK business is one which the group is aiming to strengthen, and its mega-merger with Three UK is now complete and should lead to cost synergy savings of around £700 million per year on full completion.

In addition, the Africa operation is an area of particular promise, now accounting for 20% of group income, and saw growth in service revenue of 13.5% in the second quarter. Vodafone is well positioned to benefit further from some potentially explosive growth in the region – it now has 93.7 million financial services customers - particularly given the more widespread availability and use of its services and where it is an established player.

Overall, the direction of travel should provide some relief. A progressive dividend policy will build on the current yield of 4.4%, while the €4 billion share buyback programme is now 75% complete. The numbers have led to a slight upgrade to Vodafone’s previous guidance, where earnings are now expected to be at the upper end of the €11.3 billion to €11.6 billion range previously estimated.

Of course, the telecoms sector is one based on reliability, but equally importantly on price, where there remains ferocious competition. Recent years have also required huge investment as the industry moves on, such as being part of the new 5G network, with the benefit of any payback not being felt for any number of years.

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Unfortunately, years of underperformance weigh heavily on investors’ minds, and it will take some time for those painful memories to be erased. The shares have languished for some considerable time, having fallen by 65% over the last 10 years and by 24% over the last five. However, more recent progress has been reflected in a bounce of 23% over the last year, as compared to a gain of 20.5% for the wider FTSE100 and a warm reception to the update at the open.

While the strategy is clear, the transformation in train and the valuation undemanding, the market consensus of the shares as a hold reflects that caution will remain the watchword for investors as the transformation unfolds.