Vodafone fails to reassure despite improvements in Italy, Spain

Directors reiterated their full-year target of growing adjusted operating profits around 3% and generating €5.4bn of cash before payments in mobile spectrum launches.

Reported revenue of €11bn in the three months to 31 December was down 7% year-on-year as a 6% decline in Europe was surpassed by a 11% contraction in the rest of the world.

But strip out foreign exchange movements, asset sales and accounting changes, and then organic service revenues grew 0.1% to €9.8bn, which while slowing from the 0.5% in the second quarter. Total service revenues were down 0.8%, which was worse than analyst expectations for a decline of 0.7%, mostly due to a misfiring price promotion at South Africa's Vodacom that had been revealed a day earlier.

European consumer service revenues fell 1.1% or 1.3% if excluding UK handset financing or rising 2.4% if excluding Italy and Spain, where Vodafone has been badly bruised by stiff price competition, though this was said to have moderated as the quarter went on, allowing "improved commercial momentum".

German growth unexpectedly slowed, which was a particular disappointment as this market will become one of the largest in the group once the acquisition of assets from Liberty is completed. UK was fairly consistent, with service revenue growth slowing to 0.9% from 1.1% in the preceding quarter, or down 4.5% if including the drag from mobile handset financing.

Expansion of service revenues from the rest of the world was more encouraging, at 4.9%, as the decline in South Africa was blamed on pricing initiatives was offset by good growth in Turkey, Egypt and other African markets.

Across the group, mobile contract churn reduced 2.0 percentage points year-on-year, with net additions of 747,000 mobile and 341,000 broadband contracts, with the converged base up by 190,000 in the quarter.

Chief executive Nick Read, who took over at the helm at the start of October but has seen the shares continue their slump to near a decade low due to worries about cash, debt and sustainability of the dividend, was encouraged by the lower mobile contract churn and improved customer trends in Italy and Spain, though he acknowledged that these have not yet translated into financial results.

"We are moving to implement a radically simpler operating model and to accelerate our digital transformation, as demonstrated by the organisational changes we have announced in Spain and the UK," he said, also referring to this week's announcement about an extend of the current network sharing agreement with Telefonica O2 into 5G.

He added that after these arrangements have been finalised, the companies also intend to "explore opportunities to monetise our UK tower assets", as has been mooted in the press recently.

Vodafone shares fell to a new low on Friday, just above 140p, down 34% over the past 12 months to the lowest in almost 10 years.

Analysts at RBC Capital Markets noted that a decline of 0.8% in organic service revenues was slightly below consensus of 0.7%, though this was not unexpected after Vodacom's results on Thursday.

The European business was broadly in line at -2.1% compared to the consensus forecast of -2.2%, though Germany missed with revenue of +1.1% versus consensus of +1.5%.

George Salmon, analyst at Hargreaves Lansdown, said if Read sells the UK towers assets, Vodafone would then be squarely focused on its mobile and broadband offerings. "That might sound sensible, but there are two obvious problems."

"There’s not much to choose between the different providers these days, other than the price they charge. That makes them particularly vulnerable to competition, something Vodafone’s found out the hard way in markets from India to Italy.

"We also can’t help but feel part of the motivation for selling the towers businesses would be to shore up a balance sheet that’s creaking under the weight of close to €30bn of net debt. So, while a yield of close to 9% will surely turn a few heads, investors shouldn’t forget the combination of weak revenue growth and a balance sheet laden with debt mean these are testing times for Vodafone.”

Michael Hewson at CMC Markets noted that the shares have fallen over the past year due to concerns about the size of its debt, the size of the dividend as well as future costs with 5G licences coming up for bidding.

The dividend yield of 9% "in the longer term isn’t sustainable" as it is not fully covered by profits, he noted, "which means that the company is having to fund the payout by way of borrowing".

Hewson observed that the trading update doesn’t appear to have convinced investors much over many of those worries, only on the improved customer trends in Europe.