Vodafone Results Below Par But Dividend Increase Maintained

| About: Vodafone Group (VOD)

Blaming southern Europeans for cutting back on using their mobile phones, Vodafone (NASDAQ:VOD) released six months' group revenue to September 30 down 7.4 percent to £21.8bn ($34.9bn). In Southern Europe, service revenue dropped a massive 9.8 percent as the eurozone debt crisis drove customers to cut back on their phone bills or to give up on mobile calling altogether, particularly in Italy and Spain.

In comparison, the group's first-half adjusted operating profit rose 2.2 percent to £6.2bn ($9.9bn), thanks to a strong performance in the United States, which accounted for over half the total. Southern Europe accounted for around 18 percent of operating profit.

Nevertheless, weak trading, as well as adverse currency moves, and writing down £5.9bn ($9.4 billion) on the value of its business in Spain and Italy sank Vodafone results into a first-half net loss of £1.98bn ($3.17bn), compared to a profit of £6.68bn ($10.7bn) a year earlier.

In comparison, Vodafone's European peers such as Deutsche Telekom (OTCQX:DTEGY) last week reported a 0.1 percent decline in third-quarter revenue, taking a Euro 7.4bn ($9.4 billion) writedown on its T-Mobile USA unit after a deal to merge it with MetroPCS Communications Inc. (PCS), while Telefonica (TEF), Spain's biggest telecommunications company, reported a sales drop for the same period of 1.6 percent.

Organic service revenue down

Organic service revenue is a key financial metric for mobile phone companies which in Vodafone's case reflects ongoing income, but not one-off items such as handsets, the impact of acquisitions and currency fluctuations. For the six month period, organic service revenue growth declined by an overall 0.4 percent.

Vodafone posted a 1.4 percent fall in group organic service revenue in the second quarter - the first decline in 10 quarters, due to the sharp slowdown in its southern European business where organic revenues declined 11.3 percent, in comparison to an increase of 0.7 percent in northern Europe and up 4.1 percent in its emerging markets. The UK market also saw a contraction, with service revenue decreasing 2.1 percent, partially offset by an increase in data revenue.

Vittorio Calao, Vodafone's chief executive, said:

"We have continued to make progress on our strategic priorities over the last six months, with good growth in data and emerging markets in particular. In the short-term, however, our results reflect tougher market conditions, mainly in Southern Europe."

With these results, Vodafone is also writing down the goodwill of its operations in Spain and Italy by £3.2bn and £2.7bn respectively. That 'still' leaves the carrying value of goodwill for the businesses at £2.4bn and £7.2bn pounds respectively at the end of September.

The question for me is: will this be enough and will Southern Europe not get much worse? How long will it take Vodafone to turn around its activities in these countries?

Dividend safe; at least for now

In line with its dividend per share growth target of at least 7 percent per year until March 2013, Vodafone confirmed an interim dividend per share of 3.27 pence, up 7.2 percent, payable on February 6, 2013. However, the group did not disclose its dividend targets beyond 2013.

Vodafone's 'core' dividend compares well, as I reported in an earlier article, with European competitors such as Telefonica (NYSE:TEF) - which is embarking on a major offensive to pay down debt - France Telecom (FTE), Dutch KPN (OTC:KKPNF) and Telekom Austria (OTCPK:TKAGY) all having cut or scrapped dividends, while Deutsche Telekom (OTCQX:DTEGY) has not changed its dividend plan for 2012.

Verizon dividend: share buy-back instead of a special dividend?

Earlier this week, Verizon Wireless announced that it is to pay $8.5 Billion to its two co-owners Verizon Communications Inc. (NYSE:VZ) and Vodafone, in one or more tranches, "by the end of 2012" (has the Fiscal Cliff issue something to do with this?). Vodafone's portion will be about $3.83 billion, down from $4.5 billion in 2011

Last year's dividend payment of $10bn, announced in July 2011 and paid in January 2012, marked Verizon Wireless' first dividend payout since 2005. Before last year, Verizon had withheld the dividend from the 55/45% partnership in order to focus on paying down debt. Verizon Wireless' still has no declared dividend policy, leaving its owners unsure whether they will get a dividend payment or not.

Once it has received the cash (approx. £2.4bn), Vodafone intend to use £1.5bn ($2.4bn) to fund a share buyback programme. It remains unclear what it will do with the remainder and whether it will use part of the remainder for another special dividend. In comparison, when Vodafone received the £2.9bn dividend from Verizon during January, some £2bn was distributed to ordinary shareholders through a special dividend.

Full-year outlook

Together with the half-year results, Vodafone lowered its full-year outlook. It is now not expecting much revenue growth, if any. It plans to cut operating expenses in Europe further by £300m in fiscal 2014.

Full-year operating profit will be in the upper half of the estimated range of £11.1bn to £11.9bn ($17.8bn to $19 bn), while free cash flow will be in the lower half of the previously indicated range of £5.3bn to £5.8bn ($8.5 bn to $9.3bn) indicated in May 2012. This is how Mr Colao worded it as follows:

"Overall performance in our controlled operations in the first half of the 2013 financial year has been slightly below our expectations, mainly as a result of a further weakening in the macroeconomic environment. However, this has been offset by a very strong performance by Verizon . We expect the environment to be similar in the second half of the 2013 financial year."

"We now expect the group EBITDA full-year margin decline to continue its improving trend year-on-year, excluding the impact of mergers and acquisitions and restructuring costs."

In conclusion

Vodafone is in a better position than many of its European rivals thanks to its strength in faster-growing U.S. and emerging markets, and continues to pay a dividend when others have cut back or have stopped paying a dividend altogether.

With Verizon Wireless performing more strongly that any of Vodafone's European businesses - becoming an increasingly more important part of the group for cash and growth - we were disappointed by the smaller-than-expected dividend from Verizon Wireless.

Nevertheless, Vodafone continues to be highly cash generative with free cash flow of £2.2bn for the six months together with £2.4bn dividend due from Verizon Wireless by the end of 2012.

Disclosure: I am long VOD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We run the Dividend Income Portfolio, which owns a shareholding in Vodafone Plc, purchased when the share was historically undervalued as per our valuation methodology. Currently, Vodafone is neither undervalued nor overvalued.

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