Why Vodafone Is a Buy

I am looking at Vodafone (VOD) and I like what I see. Earnings have grown at an annualized rate of 21.8% while dividends have grown at 20.45% during the 1999 to 2009 period. Net debt divided by net debt plus equity is 29.75% which is within my 30% extra due care required threshold. Operating cash flow is strong and growth in estimated free cash flow (EPS + debt – capex) has been strong growing at over 17% annualized over the past decade. The stock is yielding over 6% and is trading at a multiple of 8.21X 2009 expected earnings and 9.18X average 6 year EPS (including 2009 estimated EPS).

This is cheap. The payout ratio is up at 58.7% which is considerably higher than the 44% median payout level which rand during 1999 to 2008; however I believe the dividend is safe provided buyback activity is kept on the backburner until EPS growth catches up with dividend growth. Vodafone has used buybacks as part of its strategy in returning shareholder value.

In my view, the buyback plan has been particularly smart. The company used its shares as an acquisition currency when shares were trading high; during 2000, Vodafone shares traded at an annual average price of over $35. 2005 and 2006 saw significant buyback activity while the shares at a discount to intrinsic value.

By the end of 2008, the company had bought back just shy of 15% of the shares outstanding at end 1999; it had done this despite issuing new shares to buy assets and earnings while its shares traded at a premium to intrinsic value; and then they turned around and bought back far more than additional shares issued on acquisition, while the shares traded at a discount to intrinsic value; that is smart.

The big question on mobile phone companies is: Where will the growth come from once everyone on Planet E has a mobile? The answer to this question becomes even more pertinent when you consider the intense competition which puts incredible pressure on revenues; this in turn hurts earnings growth expectations. I share these concerns; but I think it is way overdone.

Ultimately, in my view the communication revolution has just begun; it is not ending, it is only just beginning. And mobiles will have a major role to play in the revolution; “services in your hand” is a huge potential growth area.

Think of it this way; in India, the government has embarked on a major project to create a unique identification (UID) for every citizen. This project is led by Nandan Nilekani, the ex CEO of Infosys (INFY). It is a huge project, getting over a billion people identified has to be huge. The present intention is to use mobile phone networks as the first step in creating the UID. There are over 700 million mobile subscribers in India, so it is a good place to start. The mobile operators have a massive network of consumers waiting to be monetized; so far the networks have been monetized only using voice and data services.

Eventually, the mobile operators are in a unique position to monetize the network; but to do this the emphasis must change from voice and data services to the broader consumer services segment – this is where the growth will come from and the potential is huge. There are so many on hand consumer service applications. Already money can be wired using an SMS; a check payment can be issued via mobiles; videos and music can be downloaded onto a smart-phone – the mobile operators need to take the initiative and profit from this potential instead of leaving it mainly to the smart-phone manufacturers.

As of today, mobile service operators profit from data and voice charges associated with the value added services; but in truth, they need to re-invent themselves to transition to a broad consumer services provider instead of a voice and data services provider. The most innovative networks shall emerge big winners.

The future is wide open; tomorrow perhaps it will be possible to use your mobile as a credit card; the day after could it serve as your passport? Would you like to carry your biometric data on your mobile; perhaps a global travel visa, with strong inbuilt biometric security features is something needed in this increasingly dangerous world. The game is open wide for the best innovators and in my view Vodafone is.

In my view VOD is a buy for traders, investors with a 12 to 24 month horizon, investors who adopt a cycle view of 5 to 6 years and for buy and hold investors at prices below $25; prices at $17 are unlikely, but at those levels I would consider it a strong buy. A bullish price target of $57 by 2014 is not unreasonable to expect. The “normal” expected value of VOD is in my view $43-$45 by 2014; this is a small premium to forward fair value of $39.

Please refer to VOD on the Quant Report for insight into numbers referred to above.

Disclosure: No holdings; with intent to buy a position fairly soon.

Comments

[jwalantsoneji:]

I don't understand the connection between Vodafone and the Unique Id project. Please elaborate.

Sep 29 11:08 PM

[Paul Harper:]

Shiv, good article, have been a holder of Vodafone on LSE for ever & a day & also a holder of the ADR for the last 3 years.
Anywhere under 22 is a great buy in for the stock, imo, developing markets are adding to the bottom line at a growing rate.
For me, it would be good to see VOD finally exiting Verizon Wireless & cancelling out some long term debt. The remainder to buy into some further GSM based opportunities.

mmm ... $45bn from VZ, 30% on debt, 5% on further share buyback & acquire Zain Africa for $10.5bn... now there is a real scenario for growth & value !!

Sep 30 07:00 AM