The fall and rise in Vodafone‘s (LSE: VOD) stock price has been entertaining to watch in the last couple of days. If you are tempted to bet on it, you should consider the risks associated to its free cash flow profile and its debt pile before hitting the buy button in the next 12 months.
From Hell To Heaven In 24 Hours
Vodafone was down more than 3% in the wake of poor full-year results on Tuesday, but it has risen 4.5% today, as remarks from John Malone, chairman of Liberty Global, made the rounds after the market closed yesterday.
Guess what? The two companies would make for a “great fit“, Mr Malone said.
“Comparing Vodafone to ‘a big banana in the jar,’ Malone said: ‘The question is: how do you get your hand out of the jar with the banana,'” Bloomberg wrote yesterday.
My advice is to focus on fundamentals rather than on takeover speculation, which has boosted Vodafone over the last 12 months and currently accounts for 25p to 35p of Vodafone’s 235p valuation, according to my calculations.
0.1% Quarterly Growth — A Beat?
Investors who bought into Vodafone stock ahead of full-year results were left with a bitter taste in their mouth.
Vodafone’s operations in Germany fared much worse than expected, while its guidance for 2016 Ebitda came just in line with consensus estimates at between £11.5bn and £12bn. Trends for organic service revenue are encouraging on a quarterly basis, trailing results show, but growth is nowhere is sight.
“We returned with group organic service revenue growth in the last quarter, after 10 quarters, albeit it a small one, plus 0.1%,” Vittorio Colao, chief executive, said in a call with analysts after the results were announced. Analysts were expecting a 0.0% growth rate.
Mr Colao added that “Europe organic service revenue, at minus 2.4%, is an improvement versus the previous quarter, essentially driven by commercial execution and some price stability; and, of course, data growth.” That’s a fair assessment, but other problems may lie ahead.
The Spotlight Is On Debt & Free Cash Flow
Vodafone met its full-year guidance of £1.1bn for free cash flow, with year-end net debt at £22.3bn, which carries an average interest cost of 4.7%. That’s £1bn in interest payments a year, which isn’t exactly small change — it equates to about 30% of Vodafone’s adjusted operating income.
Nick Read, chief financial officer, added that “to arrive at a pro forma for FY ’16 (net debt), we obviously add the India spectrum that we secured, dividend and then we have positive guidance free cash flow, gets you to circa around the £28 billion” net debt figures.
“This does not include the $5.2 billion of Verizon Wireless loan notes and does not include the FY ’16 spectrum auctions,” he noted, saying that moving into 2017, Vodafone will return to a capital intensity of 13% to 14%, and “the free cash flow starts to de-lever the company.”
In the light of a significant debt pile, Vodafone’s projected free cash flow profile plays a rather important part when it comes to determining the risk associated to the investment. When results came out, Royal Bank of Canada told investors that Vodafone pointed to positive 2016 free cash flow “after all capex”, which “is a very vague statement given consensus is at £940m,” according to the broker.
Other analysts I talked to were similarly unimpressed.
My simple view is that while Vodafone says that it is “very comfortable” operating with a BBB+ rating, which implies net leverage in the 2x to 2.5x range, it may want to provide investors with more details about its de-leveraging plan, which could jeopardise a forward dividend north of 5% if things do not go according to plan.
