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Morningstar | Vodafone Disappointingly Cut Its Dividend; Other Results Mixed; Likely Cut FVE; Shares Undervalued

We were disappointed Vodafone chose to cut its dividend before it received regulatory approval to acquire Liberty Global’s operations in Germany, Romania, Hungary, and the Czech Republic. However, on the call, the CEO was very positive that the remedy package Vodafone offered in response to the regulator's concerns will suffice for the deal to be approved. That said, we are still not wholly convinced regulators will sign off. Thus, we continue to exclude the acquisition from our model.

The firm reported mixed fiscal 2019 results with revenue a bit weaker than expected as Spain and Italy continue to struggle, while EBITDA was a bit better. Additionally, spectrum costs continue to increase with the German 5G auction still ongoing and prices soaring past our projections. Thus, we expect to reduce our fair value estimate by about 10%. We maintain our narrow-moat rating and believe the shares remain very undervalued.

Vodafone reported revenue fell 6.2% year over year versus our projection of a drop of 5.7%. Continued weakness in Spain and Italy and currency weakness primarily drove the decline. Service revenue declined 6.1% in Italy and 6.8% in Spain. While there are signs of improvement in the two countries, we now think recovery will take longer than we estimated.

However, in most other European countries Vodafone is increasing service revenue. The firm's convergence strategy is picking up pace. In Germany, it added 751,000 converged subscribers during the year, doubling its base to 1.5 million, which now covers 20% of its broadband base. This led to 1.5% service revenue growth in the country. In the Netherlands, the VodafoneZiggo joint venture has the group’s most integrated fixed-line and wireless networks, with 33% of its broadband customers, and 70% of its main consumer branded wireless subscribers in converged packages. We believe convergence will also help with the recoveries in Spain and Italy.

In the rest of the world segment, service revenue increased 6.1% from the year-ago period, but fell 8% on a reported basis because of currency issues, particularly with the Turkish lira, and the divestiture of Vodafone’s operations in Qatar. While Vodacom struggled during the second half of the year in South Africa, its international division grew 11.2% for the year. In South Africa, the firm still added 2.1 million prepaid wireless subscribers during the year, taking its prepaid base to 46.8 million. We expect the rest of the world segment will continue to generate faster subscriber and organic revenue growth than Europe.

Vodafone is also working on controlling costs and is already well on its way to reaching its current three-year goal of cutting EUR 1.2 billion in annual operating expenses. This led to an adjusted EBITDA margin of 31.9% versus our projection of 31.6%. We anticipate the existing cost-cutting program will enable the firm’s EBITDA margin to continue to improve.