Vodafone: H1 in line, but German weakness continues

Vodafone reported first-half revenue growth of 1.6% to €18.3bn. Service revenue of €15.1bn was up 4.8% on an organic basis, with an anticipated slowdown in Germany offset by growth in Other Europe, Africa & Turkey. Underlying cash profit (EBITDAaL) saw organic growth of 3.8% to €5.4bn.

There was an adjusted free cash outflow of €950mn (prior year outflow: €1.4bn). Net debt dropped 12% to €31.7bn.

Following the sale of the Spanish and Italian businesses, the capital return policy has been right-sized. An interim dividend of 2.25 eurocents was declared (prior year 4.5 eurocents), and the board is now targeting 4.5 eurocents for the year.

€1bn of the €2bn buyback programme following the Spanish sale has been completed, with another €2bn to be returned next year upon completion of the Italian sale.

There were no changes to full-year guidance of around €11bn in underlying cash profit and at least €2.4bn of underlying free cash flow.

The shares fell 4.4% in early trading.

Our view

Vodafone's first half didn’t throw up too many surprises. The new strategy, plus rightsizing of the business, are starting to bear some fruit. But there’s a long way to go, and the key German business needs to move back to growth sooner rather than later.

Sales in the telecom sector should be relatively robust, as broadband and mobile services are hardly optional. Yet, over the last decade, telecom giants have had to pump huge sums of cash into building out fibre networks and snapping up parts of the 5G spectrum. The main challenge has been the low sales growth relative to spending when you look at telecoms compared to other sectors.

In response to several years of underperformance, Vodafone has an evolved strategy. There are job cuts, the proposed merger of its UK business with Three UK, and sales of the underperforming Spanish and Italian divisions.

We welcome the change, but there's a lot to do.

The key market of Germany is a perfect example of the challenges at hand. After more than €20bn of investment, growing service revenue and customer numbers is proving a challenge. Vodafone was slow to adapt to changing regulations, and when it did, it introduced a poor customer experience.

Regulatory changes mean it lost a big chunk of customers, and price hikes last year have made comparable periods tough. Management’s been calling for performance to pick up as we move to the end of this year and then start contributing positively again in 2025. If there’s one thing Vodafone needs to deliver on, this is it.

Outside Europe, the Vodacom subsidiary has some exciting growth opportunities in Africa and is targeting mid-to-high single-digit cash profit growth over the next few years. Africa could become increasingly important as the region develops, and Vodafone's leading position in several markets means it's well-positioned to benefit.

With around €12bn coming in from the planned sales, €4bn is pencilled for buybacks (€1bn has already been completed). We can only assume a decent chunk of the remainder will go on reducing debt. Key for shareholders will be the reduced dividend. At half last year’s level, this will be a hit to income investors, but still represents an attractive forward yield based on current prices. Rebasing was a good move in our eyes, but as always nothing is guaranteed.

All-in-all then, while we think the portfolio changes and new strategy make sense, the fundamental challenges that go with being a telecom remain. And with growth hard to come by, we'll need to see sustained positive progress in Germany before getting too excited.

Environmental, social and governance (ESG) risks

The telecom industry is low/medium in terms of ESG risk. Data privacy and security is the most significant risk driver, not only because customers are increasingly concerned about privacy, but also because cybersecurity breaches can be costly. Product quality is another key risk, particularly given the networks they manage are considered critical infrastructure. Carbon emissions, human capital and business ethics are also risks worth monitoring.

According to Sustainalytics, Vodafone’s management of material ESG issues is strong

Vodafone has a board-level ESG committee to oversee its ESG program and track key targets. Executive pay is partly based on ESG performance, with a 10% weight in long-term incentives. The company is certified for information security management, meeting industry best practices. Vodafone also has a third-party ethics hotline for anonymous reports and a specialist team for negotiations. However, the company has faced regulatory scrutiny and fines for quality and safety issues, indicating possible gaps in product governance.