As chief executive of the beleaguered telecoms group Vodafone, Nick Read has a job on his hands trying to convince investors that he can provide a decent return on their equity.
The shares have fallen by a quarter since he was appointed three years ago and are still lower than they were at the start of this year. That’s even after they closed 4.8 per cent up yesterday on the back of earnings and cashflow guidance for this year.
Adjusted operating profits are now expected to be between €15.2 billion and €15.4 billion, from a previous range of €15.0 to €15.4 billion. But a track record of notching up growth in revenue and returns is what’s needed to gain investors’ confidence over the longer term.
Spectrum payments and restructuring costs associated with its acquisition of Liberty Global European assets contributed towards a free cash outflow of almost €1 billion during the first half of the year, which also helped push net debt up to €44.3 billion. That’s equivalent to 2.8 times earnings before tax and other charges, within a target range for a multiple of between 2.5 and 3, although there are still plans to reduce that.
Service revenue, which accounted for 85 per cent of the group total, rose just 2.8 per cent during the first half of the year, against a decline of 0.1 per cent last year. It rose only 0.8 per cent and 0.3 per cent on an organic basis during the 2020 and 2019 financial years respectively.
So what’s hindering revenue growth? Competition, which is at its most intense in the Italian, Spanish and Portuguese markets. That has led to pricing wars and inhibited Vodafone in reaching greater scale.
The UK is a prime candidate for network partnerships or mergers, says Read, but for those to be successful there needs to be regulatory support rather than punitive measures applied to operators gaining scale.
Vodafone is also eyeing growth in Germany, the only top five European market to have experienced growth in average revenue per user for both mobile and fixed connectivity products like broadband since 2017. Only 18 per cent of Vodafone’s mobile customers in the country also buy additional products at present, so cross-selling is an option.
Business customers could also prove more fertile ground, due to EU digital funding programmes running into the hundreds of billions of euros.
If there’s one thing that Read can point to, it’s the spin-off of its Vantage Towers mast business, in which it retains an 82 per cent stake. That business, which trades on the Frankfurt stock exchange, has recorded a share price rise of about a fifth since its shares were listed in March, valuing it at €14.9 billion, and has been slapped with an enterprise value of almost 20 times forecast earnings before tax and other charges for this year. Compare that to a forward multiple of just over five for Vodafone.
Vodafone’s pluses? Adjusted free cashflow guidance has crept up by €100 million to at least €5.3 billion this year, ahead of €5 billion last year, though that excludes spectrum payments, restructuring costs and investment expenses relating to the Vantage Towers business. It’s also pledged to pay an annual dividend of 9 cents a share, which leaves the shares yielding about 6.4 per cent at the current share price.
Its rival BT’s underperformance has invited speculation that the major shareholder and telecoms magnate Patrick Drahi will agitate for greater change in BT strategy or else launch a fully-fledged takeover approach. Vodafone’s sluggish performance and lowly valuation might lure activists on to its shareholder register. But cheap shares are not enough justification for retail investors to follow suit.
Advice Avoid
Why Lowly valuation is justified by weak revenue growth and returns
Focusrite
The loyalty of music nerds has made Focusrite an Aim darling. Demand for music and audio recording equipment from podcasters and musicians hunkering down during lockdown not only offset a decline in appetite from gigs and theatre productions, but propelled organic revenue up by more than a quarter in the year to the end of August.
The pandemic switched the shares up into another gear and they have more than quadrupled in value since the end of March last year. Being a pandemic winner is not the only thing Focusrite has in common with technology stocks — it has the lofty market valuation to match. Priced at almost 34 times forecast earnings for this year, investors have baked in hefty growth expectations.
So guidance from management for “modest” revenue growth this year has unsurprisingly been jumped upon by the market. Peel Hunt, the house broker, had expected revenue and earnings to decline on last year’s exceptional performance. But its analysts upgraded their rating on the shares from “add” to “buy” and increased forecasts for revenue this year and next by 17 per cent and 16 per cent respectively. Thus far, there has been no decline in demand, Tim Carroll, chief executive, said, although growth has slowed.
The group is highly cash generative, with a cash conversion rate of over 100 per cent of profit last year. That’s an attribute that has helped fund several acquisitions, most recently the $24 million purchase of Sequential, the US synthesiser company. Historically, it’s made bolt-on acquisitions that are complementary to its existing product ranges or geographical footprint, but management’s appetite is growing bigger and it could increase the size of purchases, which could mean it taps the market for funds. Businesses in the microphone or software markets are potentially attractive, Carroll said.
Allocating cash towards deals means the group is no income stock. The dividend may have been increased by almost a quarter for 2021 but the shares offer a dividend yield of only 0.3 per cent. At the current valuation, investors could do with pausing for breath.
Advice Hold
Why High earnings expectations account for increased users and entry into fresh markets
