Vodafone begins to ring the changes

Turning around a super tanker is never an easy task, especially when the company is in the midst of a highly competitive industry, but there are some signs that Vodafone Group (LSE:VOD) is beginning to ring the changes.

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 should now emerge from the turnaround is a smaller and less geographically diverse, but more focused operation.

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

General proceeds are also being funnelled to an ongoing share buyback programme totalling €4 billion, which is now half completed. In addition, even the planned halving of the dividend payment has resulted in a yield of 7.8%, effectively paying investors to wait as the transformation continues, although some of the elevated yield level comes from a decreasing share price.

Even so, the group remains a telecoms behemoth and revenues of €37.4 billion for the 12 months to 31 March represented an increase of 2%, although marginally shy of the expected €37.7 billion. Meanwhile, non-cash impairments of €4.5 billion drove an operating loss for the year of €400 million compared to a profit of €3.7 billion the year previous, with pre-tax numbers echoing that theme as a loss of €1,48 billion was set against a €1.62 billion profit in the corresponding period.

One particular area of promise is the Africa operation, which now accounts for 20% of group income. Service revenue grew by 11.3% over the year, with the group well positioned to benefit further from some potentially explosive growth in the region, particularly given the more widespread availability and use of the services which the industry provides, and of which Vodafone is an established player.

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The UK business is another region which the group is aiming to strengthen, and its planned mega-merger with Three UK should complete imminently. The merger should truly change the domestic landscape, while also providing new revenue opportunities at scale as well as cost synergy savings of around £700 million per year on completion. In the meantime, the unit accounts for 19% of group income and saw total revenue growth of 1.9% for the period. 

The most obvious thorn in the group’s size remains the German operation, which is the group’s largest and accounts for 35% of overall service revenue, which declined by 5% for the year. The unit is still suffering from 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, where the previous number of 8.5 million has been reduced to 4.2 million households.

More broadly, the telecoms sector is one which is of course 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. This becomes especially pertinent when margin protection tends to come with sheer volumes as opposed to the ability to raise prices indiscriminately.

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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. For all the progress, Germany continues to struggle and it will be difficult for Vodafone to reach an inflection point until the area returns to revenue growth, although the group expects that to happen over the next year.

The shares have languished for some considerable time, having fallen by 72% over the last ten years and by 43% over the last five. While the last quarter has seen a decent bounce, the shares have still dropped by 6% over the last year compared to a gain of 3.3% for the wider FTSE100. The strategy is clear, the transformation is in train and the valuation is undemanding, but for the moment the market consensus of the shares as a hold reflects investor reticence to fully commit just yet.