At first glance, Vodafone’s (NASDAQ:VOD) outlook appears unfavorable. The stock price is declining long-term, down almost 60% over the last five years. The dividend payout is down 11% over the same time frame. Germany, a key market for Vodafone, underperformed in Q3 2023.
That said, I believe that Vodafone’s stock price has bottomed out, and there is significant upside potential over the next few quarters. New management has made quick strategic pivots, streamlining operations and capex, tying pricing to inflation in key markets, and localizing commercial strategy. Financials are improving as management pays down debt and works towards $1 billion in cost savings. I also feel the dividend is safer than quant rantings (Dividend Safety grade of F at time of publication) would suggest.
New Leadership Making Quick Strategic Pivots
After four months on the job, Vodafone has appointed interim CEO Margherita Della Valle as the permanent CEO. I believe having the former finance chief in the top spot is great news for shareholders, especially after her comments during the Q3 2023 earnings call. During the call, I was especially impressed with her realistic, candid perspective on the company as she stated: “Declining service revenue in three of our four largest European markets is simply not good enough, and I know we are capable of doing better.”
In just a few short months, Della Valle has made quick strategic pivots that her predecessor avoided. During the earnings call, she announced a focus on three core areas: customers, simplicity, and growth. I believe all of these areas will benefit shareholders, and clearly, the board agreed with the April 27th announcement.
As described during the earnings call, customers, simplicity, and growth boil down to a few key items. First, reprioritizing opex and capex to create a seamless customer experience versus deploying the latest technologies. Second, centralizing the right departments, such as technology, while giving commercial autonomy to the local markets. To me, this indicates focused, disciplined spending and an understanding of the unique commercial needs in each market.
The third key is driving revenue and income growth agnostic to net adds. Della Valle noted during the call that they are willing to take aggressive price action, and have successfully tied pricing to inflation in eight markets. The company will be focusing on “value, not volume.” Seeing a telecom get away from KPIs and focus on driving bottom-line growth is refreshing.
Financials Improving With New Strategy
You can already see the impact of management’s new strategy in the financials. On the streamlining side, as of Q3 2023, Vodafone had already identified $500 million in cost savings against a target of $1 billion. Upon completion, this should improve the Adjusted EBITDAaL margin by more than 4ppt from the current run rate (32% to 36%).
On the pricing side, mobile ARPU is up in six reported markets (including Germany), and Vodafone expects it to continue increasing as new contracts come online with prices tied to inflation, as discussed above.
The balance sheet is also starting to improve. After spinning off underperforming assets such as the Hungarian unit, Vodafone has been able to pay down debt for three straight years. As of the most recent report, long-term debt was down to $48.5 billion from a high of $63.9 billion in 2020. With operating cash flow holding steady above $20 billion, and FCF continuing to improve, paying down debt will continue to expand Vodafone’s ability to pay down the dividend.
Stock Price Has Bottomed Out
I believe that the stock price has hit bottom and rate Vodafone a buy. Qualitatively, management’s new strategy has a lot of promise, as we discussed above. Quantitatively, the dividend is safer than it appears, and multiples are too far depressed below historical, given the performance discussed in Q3.
The current quant rating for Vodafone’s Dividend Safety is F. This score is influenced by Cash Per Share, 1-yr dividend growth rate, and % of downward revisions. Dividend coverage was also on the low end. Cash, certainly, is tighter than the industry. I tend to discount this as a risk for a utility stock with $20 billion in operating cash flow.
The 1-yr dividend growth rate and downward revisions are a factor of timing. Based on the current financials, the current dividend is affordable from FCF. With that in mind, I expect the dividend safety rating to improve to at least a D, if not better, once the last dividend cut rolls off. With a forward dividend yield above 8% at the time of publication, I feel this is a great cash flow opportunity for investors.
Beyond the dividend, valuation multiples are significantly depressed relative to the sector and historical average. P/E is down 32% to the industry and 35% to the 5-year average. EV/EBITDA is down 28% to the industry and 3% to the 5-year average. Price to cash flow is down an eye-raising 77% to the industry and 20% to the historical average. Given the abovementioned cash flow and balance sheet improvements, these ratios suggest the stock price has bottomed out.
Downside Potential
Most critically, we are only four months into Vodafone’s new leadership and strategy. It is always possible that the strategy misfires and the early success ends.
Also, telecom is a highly competitive industry, especially in Europe. European regulators heavily restrict the industry, and Della Valle acknowledges during the Q3 earnings call that regulators pay an extra close eye to pricing action. In response to criticism, Vodafone ensures that social tariffs allow lower-income consumers to access telecom services. That said, VAT changes and pricing restrictions are a risk to the strategy.
All of that said, I believe the strategic opportunities and tangible financial improvement outweigh the risk.
Verdict
I believe Vodafone is an attractive investment opportunity, especially for those looking for dividend income, and rate it a buy. Although there remains some downside risk, the company’s improved strategy and financials make it a safer bet in the long run. With a clear strategy in place, cost savings beginning to materialize, and debt paydown underway, investors should take advantage of the stock’s potential upside.
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