Telecoms giant Vodafone Group (LSE: VOD) has been out of favour the last couple of years. But as I’ll explain in this article, I think the time has come to start buying shares in this global business.
Signs of recovery
Investors may see the last few years as a lost period for Vodafone. But the firm has been working hard over this time to reshape its portfolio and prepare for its next phase of growth.
Deals such as the acquisition of Liberty Global’s cable networks in Germany and central Europe have made Vodafone Europe’s leading ‘converged’ network operator. It’s now able to offer combined broadband and mobile services to 124m homes.
Alongside this, non-core parts of the business have been sold off. The company is also preparing to spin out its European tower business into a new organisation, which is expected to help fund a significant reduction in debt.
The group’s transformation is now largely completed. Chief executive Nick Read is now focused on completing the integration of acquired businesses and stripping out costs where possible.
Early signs are promising. Service revenue rose by 1.5% to €18,544m during the first half of the year, while adjusted operating profit was 4.2% higher, at €2,231m. However, I think there’s more to come.
Although debt levels remain relatively high, at €48bn, this is expected to fall over the next few years, as cash is generated from asset sales and cost-saving measures. I’m fairly confident the firm’s plans should add up.
Problems in India
You may have heard that Vodafone is having some problems in India. Last year, the group merged its Indian business with local firm Idea Cellular. The new Indian business has recently been hit by a €4bn fine which management say could result in the closure of the business.
As far as I can tell, the cash impact on Vodafone from this uncomfortable situation should be limited. According to the firm, it expects a reduction in free cash flow this year of around €250m, reflecting the loss of dividends from its shareholding in the Indian business.
To put that in context, Vodafone expects to generate free cash flow of about €5.4bn this year. I think this shortfall should be manageable.
Focus on the cash
Indeed, my main reason for being bullish on this stock is the firm’s ability to generate surplus cash for its shareholders. Although accounting earnings (paper profits) are being depressed by various non-cash charges, free cash flow still looks pretty strong to me.
Based on the firm’s guidance for free cash flow of €5.4bn this year, the Vodafone share price puts the stock on a valuation of about eight times free cash flow. That’s unusually cheap, in my experience.
At current levels, Vodafone shares offer a forecast dividend yield of 5.4%. That’s well above the FTSE 100 average of about 4.5%.
If you’re looking for stocks that can offer a reliable long-term income, I think Vodafone is worth considering at under 160p.
