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Morningstar | Vodafone Reported Mixed First-Half Results With Weak Revenue but Strong Margins; Shares Undervalued

Vodafone reported mixed first-half results with revenue a bit light but EBITDA margin better. We expect to maintain our GBX 250 per local share fair value estimate and narrow moat rating. Despite the roughly 7.5% increase in the local share price on Nov. 13, we believe the shares remain very undervalued. The firm reported revenue based on the new IFRS 15 accounting standard. Sales fell 5.5% versus our full-year estimate of a decline of 4.6%, but adverse currency movements and the accounting change caused 3.8 and 3.3 percentage point declines, respectively. On an organic basis, excluding foreign exchange, divestitures and acquisitions, and accounting movements, its revenue would have increased 1.5%. We believe this result is more reflective of where the firm is now, with potential for higher revenue growth as operations in Italy and Spain, in particular, stabilise.

Vodafone reported European revenue fell 0.5%, as problems in Italy and Spain more than offset revenue growth elsewhere. Italy has become more competitive since Iliad’s entrance in May. However, we expect the high cost of the Italian spectrum auction to pressure Iliad more than Vodafone. Iliad has increased some service offerings to EUR 7.99, from an initial launch of EUR 5.99, and we anticipate Iliad will continue to increase the price of its offerings, which should help Vodafone’s business over time. The Spanish market has also become more competitive since MasMovil acquired Yoigo from Telia. Vodafone has been hurt short term by its decision to not renew rights to live football matches. However, the high cost of the service was generating a poor return, so as its subscriber base stabilises it should see an improved margin.

The firm is on target to reduce its cost base for the third consecutive year. Management adjusted its EBITDA guidance under the old IFRS 18 accounting standard to EUR 14.3 billion-EUR 14.5 billion, slightly less under IFRS 15, versus our full-year projection of EUR 13.9 billion.

Outside of Europe, Vodafone’s revenue fell 7.3%, but 4.8% was due to divestitures, primarily its operation in Qatar, and 11.7% from negative currency movements, mainly from the Turkish lira. Thus, on an organic basis its revenue grew an impressive 9.2%. We continue to expect Vodafone’s operations outside of Europe will grow faster, at least in local currency terms, than those in Europe. This growth is primarily being driven from greater data usage, which is far behind the levels of its European operations.

Importantly, management also stated it plans to maintain its dividend for this fiscal year and raised guidance for free cash flow, before spectrum acquisitions, to about EUR 5.4 billion from at least EUR 5.2 billion previously. As free cash flow is what ultimately pays the dividend, we find this increase encouraging. New CEO Nick Read also stated management planned to review how the firm can better monetise its assets and that he expected at least an additional EUR 1.2 billion in cost-cutting by fiscal 2021. We believe this increased cost focus will help improve sentiment in the stock over time.