Bernstein sees Vodafone as undervalued over dividend fears

Investor concerns about Vodafone's lack of dividend cash cover are justified, said Bernstein, but upgraded its rating on the stock on the company's undervaluation in light of its agreed asset swap with Liberty Global.

Along with the announcement that Vodafone chief executive Vittorio Colao will step down later this year after ten years in charge, the group's need for higher investment spending to maintain its position in various markets has put the willies up investors, especially over the risk to cash flows and ultimately what has been a sacrosanct dividend.

These dividend concerns are fair, "but for a company that will soon cease to exist in its current form", said Bernstein, noting that the company's commitment to paying out "is almost religious".

Recent insurgencies in Italy have inflicted damage on Vodafone's European portfolio, while strength in Germany and improvements in the UK have been "insufficient" to pick up the slack, but this is "for a company that is on the cusp of major structural transformation".

The Liberty deal is expected to result around a third of operating cashflow coming from Germany, with Vodafone estimating cost and capex synergies of approximately €535m per year before integration costs by the fifth year post completion, with an estimated net present value of more than €6bn after integration costs.

Bernstein boosted its rating to 'outperform', pointing out that 'OldVod' is trading at a circa 20% discount to the sector and giving the pro-forma business a enterprise value of 17 times operating cash flow, around a 15% premium to sector multiples of 14.9x EV/OpCF on consensus 2019 estimates.

"Justifiable, as the implied multiple before integration costs represents a 7% premium to the sector, in line with Vodafone's five-year valuation history."

The catalyst will be EU approval of the asset swap for €18.4bn of Liberty Global's assets in Germany, the Czech Republic, Hungary and Romania, expected in the second quarter of 2019.

"The path to deleveraging despite the headwinds in Southern Europe and the transaction costs is convincing. Most crucially, dividend cash cover is set to improve," Bernstein said.