Verizon Communications (VZ) has found its way into the portfolios of many investors for several reasons: its dividend, the company's steady cash flows, and its status as a "safe haven" stock. Much of Verizon's appeal comes from Verizon Wireless, the source of much of Verizon's growth and cash. We believe that while Verizon Communications may be a fine company to invest in, there is a better way to gain exposure to Verizon Wireless, as well as gain exposure to one of the world's leading telecommunications companies.
Vodafone (VOD) is the world's second largest wireless company, with over 430 million subscribers, behind only China Mobile (CHL). The company has operations all across the world, including Europe, India, Africa, and the United States. And none of those operations are as crucial as those in the United States. Here in the United States, Vodafone competes in the wireless markets via Verizon Wireless, in which it holds a 45% stake. That stake contributed 42.2% of Vodafone's fiscal 2012 profits, making it Vodafone's most valuable asset.
We think Vodafone is a better way to gain exposure to Verizon Wireless than Verizon Communications. With Vodafone, an investor may be getting 10% less exposure to Verizon Wireless, but they gain so much more. We delve into the bullish thesis for Vodafone below.
Global Wireless Growth: A Tale of Two Markets
Verizon Communications does business in just the United States, and its only wireless exposure comes from its 55% stake in Verizon Wireless. While that has provided the parent with solid cash flows and profits, the growth potential at Verizon Wireless pales in comparison to that of the international wireless market.
In the United States, the wireless market is nearing saturation. Already, there are more wireless subscribers than people in the United States, and with each year, growth becomes harder and harder to find as wireless carriers compete fiercely for each net subscriber addition. Because of this, Verizon Communications will have to fight harder and harder for continued growth in each successive year.
While Vodafone's most profitable segment is its 45% stake in Verizon Wireless, the company's global presence allows it to have exposure to emerging markets, especially Africa and India, where the wireless markets continue to grow. In India, for example, Vodafone is the second largest wireless company by market share (behind only Bharti Airtel), with almost 20% of the market. As India's economy continues to grow, both in urban and rural communities, the wireless market will continue to grow as well. Currently, there is fierce competition in the Indian wireless market, and the government's sale of licenses have served to decrease the profitability of the overall market. However, consolidation in India is on the horizon, and Vodafone's scale, as well as its financial strength, will allow the company to be opportunistic if and when the opportunity to gain more share of the Indian wireless market presents itself.
Vodafone's African growth strategy is a bit murkier, due to the ownership structure of its African assets. Vodafone owns 65% of Vodacom, its African subsidiary, and in addition to that, holds its own African assets. Vodacom itself has just under 48 million subscribers in Africa, while its parent has 63 million of its own subscribers. Many large investors in the two companies believe that Vodafone should sell off its African assets to Vodacom, so that the growth efforts of both companies can take place under one roof. Should Vodafone pursue such a transaction, we feel that the shares can rise. Organic revenue at Vodafone's Asia-Pacific and African business grew 8% in fiscal 2012, blunting the impact of a 1.1% drop in European revenue. Within the Asia-Pacific region, Vodafone is confident of future growth. India and Turkey grew service revenues at 19.5% and 25.1% respectively. Revenues for Verizon Communications as a whole grew 4.6% in the company's latest quarter.
With emerging markets now responsible for 29.7% of Vodafone's overall service revenue, we are confident that the company can grow its earnings and revenues at a decent rate, thanks to continued growth in Vodafone's end-markets. In Africa, just 45% of the continent's population has a mobile device, leaving ample room for growth. With Vodafone, investors can have both growth and stability, a combination that is more difficult to come by with Verizon.
The Dividend: More Yield, More Growth
One of the core reasons investors hold shares of Verizon Communications is for its dividend. As of this writing, Verizon yields 4.562%, and its dividend has risen by an average of 4% a year for the past 5 years. With Vodafone, however, investors can pick up a stock that is currently yielding 5.289% (we calculated this yield using Vodafone's fiscal 2012 dividends of 9.52 pence per share, converting it to U.S. dollars at the current exchange rate, and factoring in the fact that one ADR of Vodafone is equivalent to 10 ordinary shares).
In addition to a higher dividend yield, Vodafone is growing its dividend at a faster clip than Verizon. Verizon Communications grew its payout by just 2.597% in its last fiscal year. Vodafone, on the other hand, increased its payout by 7% in fiscal 2012 from the year before. And that is not counting the special dividend it paid out to shareholders from its portion of Verizon Wireless' $10 billion special dividend. Over the past 5 years, Vodafone's dividends have grown at an average of 7.1% per year. Investors who truly want (or need) dividend income would do well by switching from Verizon to Vodafone, which has both a higher yield, and better dividend growth.
Valuations and the Balance Sheet: Looking Across the Pond for Value and Strength
While we do not see Verizon Communications as an overvalued stock (its trailing P/E ratio of almost 47 is distorted by one-time expenditures in fiscal 2011, including pension charges), we believe that Vodafone is even cheaper. Based on consensus estimates supplied by Reuters, Verizon is set to earn $2.50 per share in fiscal 2012, and $2.79 in fiscal 2013 (2011 earnings, as shown below, exclude one-time charges).
Based on those estimates, Verizon is trading at 17.536x 2012 earnings, and 15.713x 2013 earnings. While that is not very expensive, Vodafone is even cheaper.
Vodafone is set to earn $2.57 per ADR in fiscal 2013, and $2.69 in fiscal 2014, giving it forward multiples of 10.885x fiscal 2013 earnings, and 10.34x fiscal 2014 earnings.
(click to enlarge)To be fair, Verizon is set to grow at a faster clip in the next 2 years than Vodafone, with earnings set to grow 16.279% in 2012 (based on adjusted 2011 earnings) and 11.6% in 2013. By comparison, Vodafone is set to grow its earnings by 7.531% in fiscal 2013 and 4.669% in fiscal 2014. Beyond fiscal 2014, however, we believe that Vodafone will be able to accelerate its growth rate, as the company will derive more and more revenues from emerging markets, and diversify away from Europe. Given the fact that Vodafone is a telecommunications company, its earnings are not subject to the same pressure that other companies in Europe must deal with. The situation in Europe is, however, depressing growth at Vodafone, and it will take several years for growth to resume. We do not view this relative lack of growth (to Verizon) as an issue when it comes to investing in Vodafone. The target investor in this case are those who need dividend income, as well as dividend growth and stability. Vodafone delivers on all those fronts, with a higher dividend yield and higher dividend growth rate than Verizon Communications. In addition to this, Vodafone is, from a financial standpoint, a stronger company than Verizon.
Verizon, like most telecommunications companies, holds billions in net debt. Per its latest 10-Q, Verizon ended the first quarter of 2012 with $45.065 billion in net debt, a figure that has decreased by $1.402 billion in the past year. Vodafone, on the other hand, has telegraphed that it will work on strengthening its balance sheet, and the company has taken several steps to do so. In fiscal 2012, Vodafone sold off several non-controlling stakes, to better focus itself on core operations in Europe, Africa, India, and the United States. It sold 44% of French phone company SFR and 24% of Polkomtel. Those moves, alongside dividend payments from Verizon Wireless, have lowered net debt at Vodafone to 24.425 billion pounds, a drop of 5.443 billion pounds (at current exchange rates, Vodafone has $38.1929 billion of net debt). Vodafone has committed itself to a strategy of streamlining, and it is delivering results. Vodafone has sold of non-core assets to focus on the markets it can compete and win in (India, Africa, Turkey, for example), and those proceeds have been used to both reward shareholders and strengthen the balance sheet. We believe that Vodafone will continue to be a prudent steward of shareholder capital, and continue with its approach to strengthening the company and returning that capital to shareholders, in the form of both dividends and buybacks. Vodafone is less burdened at the present with network upgrade and spectrum costs than Verizon, which must invest billions into both spectrum and network equipment to remain competitive in the American wireless market. As such, it has less cash to use in regards to reducing debt and boosting dividend payouts (Verizon's lower dividend growth serves as but one example of this fact).
We believe that American investors looking for yield within the telecommunications sector should look outside America to find it. Though earnings growth is estimated to be lower than that of Verizon Communications in the next 2 years, Vodafone will recover once Europe repairs the damage that has been done over the past few years. That, combined with emerging market exposure will allow Vodafone to resume growing at a more normalized pace.
Vodafone offers investors exposure to Verizon Wireless, a higher dividend yield that Verizon Communications, and higher dividend growth. Add in a low valuation, a stronger balance sheet, and multiple emerging market growth stories, and Vodafone has the makings of a winning investment, in our opinion. We believe that investors who add to or initiate positions in Vodafone at this time will find it to be a wise long-term move.