Vodafone: Is the dividend cut a buy signal?

Vodafone has released its annual results. Although there was not much new on the operational side, the dividend was cut to €0.09, as was unfortunately expected (but it was probably the right thing to do). This corresponds to 6% of yesterday’s stock price (vs 10% previously). The major telcos, offering a 4.5-5.5% yield, lend it some upside if the market has confidence, like us, in the sustainability of the dividend. We maitain our Buy on the stock.

Vodafone has released this morning its annual results and announced a dividend cut.

Organic service revenue was up by 0.3% yoy for the whole year, in line with estimates. The expected 0.6% decline recorded in Q4 reflects the increased competition in Spain and Italy and headwinds in South Africa (like in Q3).

The adjusted EBITDA grew by 3.1% yoy for the whole year, perfectly in line with the guidance previously given by management at +3%.

As unfortunately expected (but it was probably the right thing to do), the dividend is cut from €0.1507 to €0.09. This corresponds to a 6% dividend yield at yesterday’ stock price (vs 10% previously).

The 2020 guidance (including New Zealand and excluding Liberty Global’s assets) is to generate an adjusted EBITDA of €13.8-14.2bn, corresponding to a low single-digit organic growth. Of course, the Board intends to maintain a progressive dividend policy in the future.

As a reminder, Vodafone announced last week that it has concluded a cable wholesale agreement with Telefonica Deutschland which will be able to market broadband services over the combined Vodafone and Unitymedia cable network in Germany, which covers 23.7m households. The European Commission could therefore approve Vodafone’s acquisition of Liberty Global’s assets during May.

Last but not least, Vodafone has also announced the sale of its subsidiary in New Zealand to a consortium comprising Infratil and Brookfield Asset Management. The subsidiary was sold for an EV of €2.1bn, corresponding to 7.3x EBITDA.

First a word about the operational side:

• In Europe, nothing new: annual service revenue declined by 2.5% yoy and lfl, while EBITDA was almost stable (-0.5%) on an organic basis and excluding UK handset financing impacts. Although all is going well in Germany (a third of Vodafone’s European business), Italy (15% of the European business), as expected, has suffered from the arrival of the new mobile entrant Iliad with a c.6% decrease in revenues, while in Spain (14.5% of the European business) revenues were down by c.6.4% with a significant acceleration in the decline during the year due to the current challenging competition in that country. Note the group has announced sharing agreements in Italy (with Telecom Italia on 4G and 5G) and Spain (with Orange on 5G) to reduce its opex and capex by around €200m.
• In the Rest of the world (24% of VOD’s business today of which half in Africa and mainly South Africa through Vodacom), service revenues grew by 6.1% yoy but by only 3.8% for Vodacom as revenues declined in South Africa in H2 due to macro-economic pressure and a new national roaming.
• As for India (deconsolidated), Vodafone Idea revenues was stable qoq in Q4 (Q3: -2.2%, Q2: -7.1%), while the EBITDA grew by 39% qoq. Perhaps a return to calm after the Jio storm. Note that, on 8 May, Vodafone Idea successfully completed its €3.2bn equity capital raise. VOD’s contribution of €1.4bn was indirectly funded through a loan secured against the Indian assets.

Global EBITDA was correct, up organically by 3.1% yoy (adjusted from the impact of handset financing and settlements), once again supported by an operating expense decline of €0.4bn in Europe and common functions. Management still targets a reduction in opex in Europe and Common functions of at least €1.2bn by FY21, compared to FY18 on an absolute organic basis, including savings in FY19 of around €400m.

Beyond the operational side, we know that pricing a telco amounts to focusing on its dividend flow. Vodafone had confirmed, after its H1 release on November, its intention to maintain the dividend at €0.15. The stock had climbed by 20% in the following weeks before falling back even lower at 130p, the market still remaining very sceptical with an eye on the debt pile. So, today, the announcement to cut the dividend to €0.09 is a win for those who had bet on such a cut.

But is it the final win and is it a buy signal?

The new dividend yield at yesterday’s stock price is 6% vs 10%. The major telcos offer a 4.5%/5.5% yield so it lends some upside for the stock if the market has confidence in the sustainability of the dividend.

As for its sustainability, let’s once again remind that on paper Vodafone should not have any problems paying it.

Excluding the deal with Liberty, the group should generate in 2019/20 an annual EBITDA of c.€14bn for capex (pre spectrum) of c.€8.5bn, leaving €5.5bn to service a net debt of c.€27bn and pay out €2.4bn in dividends (€0.09/share). Note accrued spectrum costs in 2018/19 were €2.8bn (with the majority of the €2.4bn cost of the Italian auction payable only in 2022). In 2019/20, a similar €2-3bn amount is expected with the 5G German auction. So this is quite just, but it does not include Liberty Global’s assets.

Once the deal with Liberty Global is completed, net debt will shoot up to €45-50bn but the future EBITDA (at €16-16.5bn) less the capex (€9.5bn) will leave €6.5-7bn to service the debt and pay the dividend. The current new dividend at c.€2.4bn would leave more than €4bn to buy spectrum (the remaining licences, in particular in Germany, could cost Vodafone €5-7bn in the coming years) and pay back lenders. As for the leverage, we note that once the deal is completed the net debt/EBITDA ratio should first be at c.3x…but it could fall towards the 2.5x level in two years. Therefore, the dividend could increase again from 2020.

The group will get €2bn from the sale of its subsidiary in New Zealand but we must also note that, last September, Vodafone said it was considering selling towers in order to help reduce its debt. The group currently owns 110,000 towers across Europe, 55,000 of which are directly controlled by the operator and are valued at around €12bn.

All in all, we believe the new dividend is sustainable over the long term and that the group has the means to set a progressive dividend policy in the future. So, we believe this dividend cut is rather a buy signal and we maintain our opinion at Buy on the stock (although we will revise downward our target price to account for the new dividend policy).

This release won’t have any major impact on our estimates regarding the operational side. We will, however, deploy the accounts 2021/22, which could have an impact on the DCF, and we will also reduce the dividend which should have a negative impact on our target price. The upside should, however, remain significant.

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