Vodafone: Profit Climbs, Ups Outlook

Nov.10.10 | About: Vodafone Group (VOD)

Vodafone Group Plc (VOD), the largest revenue generating international wireless carrier, announced results for the first half of fiscal 2011 (ended September 30, 2010). The company reported adjusted earnings of 8.76 pence per share (or earnings per ADS of $1.33), up 0.5% from 8.72 pence in the year-ago period.

On a GAAP basis, net profit jumped 56.5% year over year to £7.5 billion ($11.4 billion). During the first half, net profit benefited primarily from a £2.4 billion ($3.65 billion) gain on the sale of its entire 3.2% stake in China Mobile (CHL) and the resolution of certain tax-related issues, partially offset by £0.8 billion ($1.2 billion) of impairment charge on the carrier’s operations in Greece.

Consolidated revenue increased 3.9% year over year to £22.6 billion ($34.4 billion) on the back of favorable exchange rate swings. Almost half of the revenue growth was organic (up 1.8%) and came largely from emerging markets. Group service revenue (94% of total revenue) grew 3.7% (1.7% on an organic basis) year over year to £20.5 billion ($31.2 billion).

On an annualized basis, consolidated data revenue climbed 28.2% to £2.4 billion ($3.65 billion). Messaging and fixed-line revenue increased 7.3% and 4.0% to £2.5 billion ($3.8 billion) and £1.6 billion ($2.4 billion), respectively. Voice revenue dipped 1.4% to £13.8 billion ($21 billion).

Adjusted operating profit rose 2.7% to £6.1 billion ($9.3 billion) with higher contributions from Africa and Central Europe, Asia-Pacific and Middle East and Verizon Wireless, partially offset by reduced profit from Europe.

Results by Segment

Europe: Revenues from the segment decreased 4.1% year over year (down 1% on organic basis) to £14.3 billion ($21.7 billion). Service revenue in Europe declined 1.3% organically as growth in Germany, the UK and the Netherlands continued to be more than offset by decreases across Southern European markets, which were affected by continued market and regulatory pressures as well as a challenging economic environment.

Africa & Central Europe: This segment posted revenues of £4.5 billion ($6.8 billion), up 21% year over year, driven by favorable exchange rates and the full consolidation of Vodacom. Organically, service revenue grew 4.8% as continued growth at Vodacom and strong performance in Turkey was partially offset by declines in the rest of the region, which were hurt by economic difficulties and mobile termination rate cuts. Service revenue at Vodacom grew 4.5% on an organic basis, driven by solid data revenue growth, partially offset by a decline in voice revenue.

Asia-Pacific & Middle East: Segment revenue climbed 21.4% year over year (10.9% organically) to £3.7 billion ($5.6 billion). Service revenue increased 11.4% year over year on an organic basis driven by continued strong growth in India, the single biggest contributor to organic revenue growth. Service revenue in India increased 14.7% organically following a sizable growth in the wireless customer base.

Subscriber Trends
During the first half, Vodafone registered roughly 12.1 million net new mobile connections across its operations, bringing the total subscriber base to 343 million (77.8% represented by prepaid customers). India continues to be a key driver of subscriber growth with net addition of 6.5 million customers in the reported half, representing 72.6% of total net addition in the Asia-Pacific & Middle East segment.

In Europe, the company registered a net addition of 1.2 subscribers, bringing the regions total customer base to 115.4 million at the end of September 2010. Africa & Central Europe and Asia-Pacific & Middle East added 2 million and 8.9 million customers reaching respective 77.4 million and 150.7 million subscribers as the end of the first half.

Vodafone’s net debt reduced 10.4% year over year to £30.5 billion ($46.4 billion) at the end of the first half of 2010. The company generated free cash flow of £3.5 billion ($5.3 billion), down 12.8% year over year.

Capital expenditure declined to £2.7 billion ($4.1 billion) from £2.8 billion in the year-ago period, owing to lower investments in India. Vodafone also invested £2.9 billion ($4.4 billion) in licenses and spectrum including £1.7 billion ($2.6 billion) in India and £1.2 billion ($1.8 billion) in Germany.

Vodafone recently issued a dividend per share growth policy of at least 7% per annum over the next three years (until fiscal 2013). Thus, the company raised its interim dividend by 7.1% to 2.85 pence per share. The increased dividend is expected to be paid on February 4, 2011, to shareholders of record on November 19, 2010.

As Vodafone returned to organic revenue growth in the first half of 2011 and gained share in the majority of markets, management raised its 2011 adjusted operating profit guidance to £11.8–£12.2 billion from £11.2–£12 billion. The company continues to expect free cash flow in excess of £6.5 billion.

Vodafone provided a new growth strategy to exit minority holdings and seeks to focus particularly on Europe, Africa and India. As part of this strategy, the company plans to sell securities in the Japanese wireless operator Softbank Corporation for £3.1 billion ($5 billion). Early in September, the company also announced the sale of its entire 3.2% stake in China Mobile for £4.3 billion ($6.6 billion). Vodafone is reviewing all its minority holdings including a 44% interest in SFR, a French operator, and a 45% interest in Verizon Wireless, a venture between Verizon Communications (VZ) and Vodafone.

This new strategy is expected to generate organic revenue growth in the range of 1% to 4% per annum, with stabilizing consolidated EBITDA margins. It is also expected to generate free cash flow between £6 billion and £7 billion per annum over the next three years to fiscal 2014.

Our Analysis
We believe the new growth strategy will position Vodafone to take full advantage of the growth opportunities in Europe, driven by mobile data services. Additionally, Vodafone is looking to expand in emerging markets such as Eastern Europe, Asia, India and Africa to fuel growth. The company is also focused on improving shareholder returns through attractive dividend payouts, supported by a healthy free cash flow.

We believe that investors have been concerned with a less favorable business outlook in Europe (especially in Spain, Germany and the UK). Vodafone is experiencing declines in service revenue and subscriber count in key European markets due to a weak economy, regulatory pressure and stiff competition. Despite expectations of limited economic improvements in key European markets over the near term, we believe the company’s financial prospects remain attractive relative to many other large capitalization telecom carriers.

Hence, we are currently maintaining our long-term Neutral rating on the stock. The company has a short term (1-3 months) Buy rating with the Zacks #2 Rank.