Vodafone (NASDAQ:VOD) has been an interesting stock to follow over the past year. Not only did Vodafone manage to sell its 45% in Verizon Wireless to Verizon Communications (NYSE:VZ) for $130 billion, the company became a take-over target itself. AT&T (NYSE:T) was rumored to be the potential buyer. In the process, Vodafone returned around $84 billion to its shareholders.
All this positive news supported Vodafone's share price, which closed at a year-high of $41.57/share on February 28, 2014. However, Vodafone reported worse than expected earnings over the fourth quarter and AT&T announced a multi-billion acquisition of DirecTV (DTV) last month. As a result, Vodafone's shares closed at $35.01/share on May 30, 2014 or 16% lower than the year-high (see graph below).
Source: Yahoo Finance
Following the decline, the company's dividend yield increased. As a result, Vodafone now trades at an attractive 5.30% yield. In this article, I will argue that Vodafone is a buy considering the attractive dividend yield and stronger balance sheet compared to its U.S. peers Verizon Communications and AT&T.
Valuation and take-over premium
One of the main drivers behind the increase in Vodafone's shares was a potential take-over by AT&T. Investors expected AT&T to make an offer for Vodafone after the company sold its 45% stake in Verizon Wireless to Verizon Communications. An acquisition by AT&T was likely, because it made several serious comments regarding the expansion to Europe in the past. By acquiring Vodafone, AT&T would instantly become the leading telecom operator in Europe.
Despite all the rumors, AT&T announced a $49 billion deal to acquire DirecTV last month. Given the size of the deal, it is not likely that AT&T will make an offer for Vodafone in the near future. As SA contributor The Outsider explained in this article, any premium regarding a potential take-over is unwarranted. Based on its current share price, Vodafone is equally valued to Verizon Communications and AT&T. Vodafone's trailing P/E ratio is 13.47, between Verizon's trailing P/E ratio of 14.19 and AT&T's trailing P/E ratio of 13.17 (see table below).
Table source: Yahoo Finance
Vodafone faces tough competition in Europe. As a result, its revenue and earnings are under pressure. According to the fourth quarter earnings report, revenue (-3.5%) and EBITDA (-7.4%) decreased on an organic basis during the past year. The positive results in Africa, Middle East and Asia Pacific (revenue up 6.1%) could not make up for the negative results in Europe (revenue down -9.1%). Vodafone expects that the competition in Europe remains tough and that next year's EBITDA will decrease even further. Next year's EBITDA is expected to decrease between 7% and 11%.
Vodafone's expectation for next year places the valuation numbers (see graph above) in perspective. Vodafone is exposed to the European markets, while Verizon Communications and AT&T are not. In fact, analysts expect that Verizon Communications and AT&T will grow revenue and earnings compared to last year (VZ: click here, T: click here). Therefore, investors could argue that Vodafone should trade at a discount compared to Verizon Communications and AT&T, because of Vodafone's exposure to Europe.
Strong balance sheet
Despite Vodafone's exposure to Europe and the negative effect on next year's revenue and earnings, it is in great financial shape. For example, Vodafone has a net debt to equity ratio of 0.19 and a solvency ratio of 58.9%. The net debt to equity ratio will rise after the company completes the acquisition of ONO S.A. However, this ratio is expected to remain well below 0.50 by the end of the year. Overall, Vodafone has a much stronger balance sheet compared to its U.S. peers based on the most recent balance sheet (VZ: click here, T: click here).
Given Vodafone's strong financial position, it gives the company time to adapt to overcome the struggle in Europe and expand their successful business in Asia and Africa. In the meantime, the dividend is secured and the balance sheet is strong enough for the company to increase the dividend in the upcoming years. Overall, I believe Vodafone is a decent buy considering the company's 5.30% yield (higher than its U.S. peers) and I initiated a new position around $34.50 last week.
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.