Investors are running out of patience with Vodafone. Shares in the telecoms group, a staple of many investment portfolios, dropped a further 8 per cent on Tuesday after it warned of customers in its core and more profitable German market jumping ship and lowered its earnings and free cashflow estimates for the rest of its fiscal year.
The company chose the word “resilient” to describe its trading performance in the six months to the end of September, believing that revenue growth of 2 per cent and a 2.6 per cent dip in adjusted earnings were reasonable, given the challenging economic environment. Investors, many of whom tired of years of underperformance, excuses and questionable strategies, clearly feel otherwise and aren’t convinced that a grand plan to cut costs and raise prices, amid a well-documented cost of living crisis, will make all the pain go away.
Telecoms stocks such as Vodafone are capital-intensive. In this line of business, huge sums are invested improving infrastructure or creating joint ventures. Stinginess isn’t an option as technology is constantly evolving and competition is fierce.
In the six months to the end of September, Vodafone’s capital additions totalled €3.5 billion. The problem is that the group’s big investments haven’t been paying off much — a return on capital employed of about 5 per cent is extremely underwhelming.
Normally, a good way to increase the value of investments is to charge customers more. That isn’t easy when competition is fierce and is even more challenging when inflation is rampant and people are struggling to get by. Today’s soaring cost of living is a real problem for Vodafone.
All these troubles lead to one key question: is Vodafone’s coveted dividend likely to get cut again? The recent share price decline pushed the yield up to almost 8 per cent. That looks nice, but also raises alarm bells and screams “value trap”. In its latest financial report, Vodafone reported that free cashflow, the amount of cash left over after paying expenses, was in the red by €3.2 billion and that €1.3 billion had been spent on dividends. Essentially, this means the FTSE 100 constituent is shelling out more than it is making. The dividend isn’t covered by earnings, either. The general rule is that companies must earn twice as much as they are paying out. That’s not the case here. Divide Vodafone’s earnings per share by its dividend per share and you are left with a coverage ratio of 0.78.
With more cash flowing out than coming in, net debt ballooned to €45.5 billion. That’s almost double 2012 levels and far higher than Vodafone’s €27 billion market value.
On a positive note, the cost of the group’s debt is fixed at about 2.5 per cent and its recent offloading of a stake in Vantage Towers should give it a bit more headroom. But that doesn’t mean investors shouldn’t be worried. The present policy of selling assets and cutting costs to pay off debt and fund dividends isn’t really a sustainable long-term strategy and there’s a lot of expensive investments still to be made to ensure Vodafone remains competitive.
Enthusiasm about Vodafone’s potential merger with Three UK also has been lacking. The prospect of becoming Britain’s biggest mobile operator is enticing but risky. Investors have been calling for Vodafone to simplify its sprawling empire and raise cash, rather than add extra assets. Big mergers like this have been known to backfire.
Vodafone’s shares are now lower than they were back in the late 1990s and trade at only ten times forecast earnings. Normally, that would be considered cheap for a company of Vodafone’s stature and income credentials — but these aren’t normal times. The turnaround job is a tough one and patience is wearing thin.
ADVICE Hold
WHY Vodafone isn’t in a good place, but that’s reflected in the depressed share price
Wincanton
Logistics companies generally aren’t popular with investors. The sector is synonymous with fierce competition, powerful customers and wafer-thin profit margins.
Wincanton is a little bit different. The Chippenham-based company has worked hard to differentiate itself and to become indispensable to many British and Irish household names eager to outsource their supply chains. Rather than focusing merely on road haulage and warehouse management, it added specialist services such as last-mile delivery, labour resourcing, supply chain software and white-glove home delivery. That’s landed it with lots of contracts and a growing base of loyal customers.
Presumably the reason the share price has been flat this year is because of economic uncertainty, inflationary pressures and labour shortages. Logistics, after all, is a cyclical industry and the economy isn’t in the best of shape. But that response could be considered harsh. Wincanton isn’t your run-of-the-mill goods haulier or the same company it was several years ago. In 2022, it’s well diversified and better equipped to handle a recession, as evident from the 9 per cent of revenue growth it achieved in the six months to the end of September. It has 139 customers with diverse characteristics, including the government and BAE Systems, generates about 80 per cent of sales from non-discretionary consumer spending and requires most customers to pay for any costs incurred plus an agreed-upon margin.
Other things to like include its profit-enhancing investments in automation, a well-covered 3.3 per cent dividend yield, a very robust balance sheet with barely any debt and a reputation for maximising the returns on assets. There’s a chance it could get acquired, too. Logistics is a fragmented sector and companies with a decent hold on the UK market can be attractive targets for big multinational players.
These factors don’t appear to have been priced into the shares, which trade at or below their five-year average forward price-to-sales, enterprise value/earnings before interest, taxes and other charges and price-to-earnings multiples.
ADVICE Buy
WHY Wincanton’s valuation does not reflect its prospects
