Vodafone (VOD) has been a very rewarding stock to own over the last four years. The share price is up over 50% and paid out over 25% of the purchase price in dividends. It is frequently suggested as providing the best of both worlds -stock with technology-style growth and utility-style dividends. Let's see if it really is too good to be true or if it's time to take my profits and move on.
Revenue / Gross Profit
Vodafone's gross profit margin is a slightly worrying 32%. It has been decreasing every year since 2006. Revenue growth has also slowed. Since 2007 (the company made a loss in 2006) revenue growth has averaged 8% per annum. However, the last two years it has been just 1.1% in 2012 and 3.2% in 2011. These are not good signs for any company, especially not one that is supposed to be providing growth.
Vodafone's net income and earnings per share have decreased by about 20% each (slightly slower per share thanks to buybacks). When we drill down we see that this decline has mostly been in Europe (-1.1% revenue, -9.6% profit) with the emerging (mostly) AMEAP markets growing revenue by 8.0% and profit by 22.4%. However, this performance was weakened by worsening exchange rates so the reported income only grew by 3.7% and profit by 15.7%. Unsurprisingly, the markets that performed worse in Europe are Portugal, Italy, Ireland, Greece, and Spain (the infamous PIIGS economies from the euro sovereign debt crises) as consumers continue to tighten their belts. The question is whether you believe these countries will turn things around and return to their free-spending ways?
Vodafone seems to have its debt under control and is gradually bringing it down. Since 2009 they have reduced Long Term Debt by about 13%. Debt was 75% of gross revenue last year, steadily down from 103% in 2009. Interest expenses were 4.2% of revenue last year. Debt to Equity has remained fairly flat over the last four years at about 45%. - this is manageable.
Vodafone has a nice cash stockpile (120% of last year's net income or 18% of revenue). This is a healthy sign, as is the fact that the cash is being generated by the regular free cashflow, not extraordinary events.
Vodafone is in a very competitive business, and one place we see this is in the low rates of return they achieve. Return on equity and return on assets have been gradually trending downwards for the last three years (from 9.6% to 9.0% and from 5.5% to 5.0% respectively).
Strategy / Macro
Vodafone is well diversified globally, operating in "over 30" countries. 70% of operating revenue is from Europe, 30% is Africa, Middle East, and Asia Pacific. 78% of operating profit comes from Europe with 22% from AMEAP. This means they have a promising exposure to developing markets - Africa is particularly interesting for wireless companies due to the large distances and lack of existing wired infrastructure there.
However, Vodafone is coming under pressure in Europe from traditional telecom operators who are offering bundled phone-mobile-Internet-TV services that Vodafone can't compete with. They have started to invest in fiber-optic networks (by acquiring Cable and Wireless in the UK, and a $1.3B joint venture to build one in Spain). This might be a winning strategy but it is risky. Many companies have lost a lot of money investing in fiber-optic infrastructure. One notable example is Cable and Wireless whose shares lost about 60% of their value in the two years before Vodafone purchased them.
The telecommunications market is very competitive and the product is practically a commodity now - I can go down to the store as soon as I finish this article and walk away with a completely different mobile phone company within about fifteen minutes (I'm on pre-paid). Companies that have defensible competitive advantages are better long term investments than those that must fight on price.
As we saw in the Net Income section, Vodafone's performance recently has been significantly boosted by its 45% ownership of Verizon Wireless (VZ). There has been much discussion about if Verizon will finally make Vodafone an offer they can't refuse. Unlike many people, I do not think this is a good sign. Short term it may well boost the share price as everyone loves a deal. Long term however, they are selling a profitable asset (possibly their best business unit) which is not what you want to see. They may get a price they can't refuse, but given their recent performance in Europe / Rest Of World they may also be selling the family silver to pay grocery bills.
There are even rumors that AT&T (T) and Verizon will actually combine to buy all of Vodafone. AT&T would get the overseas businesses while VZ would get full control of its domestic wireless business. I had to check that these were not April Fool's announcements, but they are being reported widely enough that there seems to be some factual basis behind them. According to one source, the offer would be $3.93 per share (each ADR represents 10 shares) which would be very nice for Vodafone shareholders as it's about a 40% premium on the current share price of $2.81. Verizon has denied these rumors (although that's what they'd do whether they were true or false at this stage). It's definitely something to keep shareholders interested for the next few weeks though.
Overall, I am now looking to exit my Vodafone position, but not urgently. The potential buyout (of either the US operations or the whole business) is the wildcard that is keeping me in. Selling now would mean missing out on the possible share-price windfall that either of those events would represent. I will most likely use a simple trailing stop to exit my position as this will give me upside exposure relatively cheaply (the loss of the stop distance from what I'd gain from an immediate or a limit sell) while protecting me from downside if things don't work out as I hope.
Additional disclosure: I have a trailing stop sell order in. This may or may not hit in the next 72 hours (it's unlikely).