Limited Upside For Vodafone Spells Caution For Investors

| About: Vodafone Group (VOD)

Despite the current Eurozone slowdown and Vodafone Group's (NASDAQ:VOD)'s significant exposure to the European markets in terms of revenues, the company has performed reasonably well compared to its peers. However, even with a company as diversified as Vodafone, emerging markets haven't quite provided the growth that the company expected in order to offset the slowdown in Europe. The company's management has also revised down its medium-term outlook for its free cash flows. The stock has performed reasonably well on a YTD basis, increasing in value by 6%. However, we believe its appreciation potential to be limited in the absence of key catalysts for growth. It remains attractive from a dividend perspective, currently yielding 5%.

VOD, a global telecom company, is one of the world's biggest mobile companies, with its operations covering over 30 countries. Its operations in Europe mainly cover Germany, Italy, Spain and the U.K., and the company has a significant presence in India, Australia and Ghana in its Africa, Middle East and Asia Pacific businesses. It also has a non-controlling position in the U.S. telecom giant, Verizon Wireless (NYSE:VZ). VOD, with almost 15,000 outlets globally, has a market capitalization of almost $146 billion, and its shares are listed on the London Stock Exchange, as well as the NASDAQ.

As mentioned previously, the group derives its revenues from its European and AMEAP (Africa, Middle East, Asia Pacific) segments, with the European business accounting for almost 70% of its revenues. In Europe, Germany continues to be the company's biggest market in terms of revenue generation. According to the latest yearly results posted, the company has a total mobile market share of 35% in Germany. VOD also boosts a leading market share in its Italy operations, which, despite the overall political and economic turmoil, have remained steady. India has been one country of tremendous growth for Vodafone in terms of customer additions, as it has increased its customers by almost 440% over the last few years. As of the financial year ended 2012, the company reported a total of 150 million customers in India alone. With demand for high speed internet on mobile phones increasing, the company has done well to tap into this emerging market. The company is primarily focused on data services, as well as emerging markets, which are being driven by rising demand for internet on smartphones, as well as strong growth in developing economies. Going forward, these two can be identified as some of the growth drivers for the company. In future, the data segment of the mobile market is likely to grow, which is also evident in VOD's rise in data revenues and a fall in voice revenues, and the company, with its 240,000 sites worldwide, is well poised to gain from increased data usage.

Vodafone has consistently improved its revenues over the years, despite the recent slowdown. Since 2008, revenues have grown by almost 7%, which even though is modest growth, is impressive considering declining revenues for its German rival Deutsche Telekom (OTCQX:DTEGY) and the overall cut in spending by consumers hit by the recession, especially in Europe, the company's major revenue source. However, the latest quarterly results have been rather disappointing for the company, with weaker spending in Italy and Spain having an adverse effect on its revenues. Service revenues from Spain declined by 10% in the first quarter of the year on an organic basis, largely due to lower consumer confidence amidst the soaring unemployment rate in the country. Data revenues continued their strength in the quarter, growing by almost 25% in Spain due to increased smartphone penetration, as well as reduced subsidies. Data revenues that now account for almost 16% of the company's service revenue continue to show sound growth in all its regions, growing by over 17% in the quarter recently ended. Revenues from its European operations declined almost 8% in the quarter recently ended. On the face of it, this is a significant deterioration, however, much of the decline was due to unfavorable exchange movements. Moreover, a decline in mobile termination rates largely offset the growth in data revenues. A decision by the competition commission to cut the termination rates, even though beneficial for customers, is hurting telecom carriers. Going forward, companies like Vodafone and O2 have been instructed to further reduce these rates. Vodafone currently has a significant exposure to the prepaid market (80%), and with rates decreasing, VOD can be adversely affected.

Germany, the company's biggest market in Europe, continues to show strength in operations with service revenues increasing almost 4% on an organic basis. Data revenue growth led by high smartphone penetration and increase in handsets sold continues to aid the company's German business in posting strong results. Vodafone saw a slight deterioration domestically as well, largely due to lower consumer spending and competitive pressures. T-Mobile's recent launch of unlimited call, text and internet also had an effect on its domestic results.

Below is a brief summary of the company's key metric as of the quarter ended June, 2012, which shows the deterioration in Europe in terms of customer additions.

Mobile customers 2Q2012























Overall, organic growth for the company has slowed recently due to the slight slowdown in developing economies, which has provided a cushion for the company in the recent past. Slowdown in these economies means that Vodafone's relatively poor performance in the European markets will be compounded.

Financial Position

Despite Vodafone's major exposure to Europe, and the economic weakness in the region, the company has grown its revenue by 7% over the last five years, which even though modest, is higher than DTEGY. Since 2007, its rival's revenues have declined by almost 2%. Vodafone's operating margins of 14% are also higher than DTEGY, which indicates its better operational performance. As at March end, 2012, the company had a total of 8.5 billion pounds in cash, including short term investments, which have increased by almost 50% over the last five years. The company has a debt-to-equity ratio of almost 45% as of the most recent quarter, which is lower than DTEGY (130%) as well as the industry average of 55%. Overall, total debt for the company has been consistently declining due to bond repayments and exchange fluctuations. As of the year ended 2012, the company has total obligations of around 14.3 billion pounds, including borrowings and capital commitments, which need to be settled in another year. However, looking at its cash strength, it can be expected that the company will be able to meet its liabilities.


In the year ended 2012, the company paid total dividends of 6.6 billion pounds, which represents a compounded growth of 16% over the last four years. Last year, the company declared an interim dividend of 3.05 pence, showing a growth of almost 7% over 2010's dividend. The stock offers an attractive dividend yield, currently 5%, which is well backed by its operating cash flow yield of 14%.


Vodafone is currently trading at a forward price of 11.2x relative to its earnings, which is at a discount to DTEGY's 16.2x. VOD's P/S and P/B of 2x and 1.3x are at a premium to DTEGY's 0.6x and 1.14x, respectively. Moreover, VOD's EV/EBITDA of 8x is also at a premium to DTEGY's EV/EBITDA of 5x.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.