Shares in Vodafone (LSE: VOD) have underperformed the market since the start of the year amid concerns about the downside risks from competitive pressures in Europe and an impending departure of its CEO Vittorio Colao.
Convergence
During the decade under Colao’s leadership, Vodafone has made the transformative journey from mobile operator to become a converged player, providing both fixed and mobile services. Via a combination of acquisitions and organic capital expenditure, the company has invested heavily to gain a foothold in fixed-line and pay TV markets.
Most recently, Vodafone Australia, the company’s joint venture in that country, has agreed to merge with local broadband provider TPG Telecom in a bid to bolster its competitive positioning in Australia’s telecom sector.
Liberty Global
Elsewhere, the group also agreed to pay €18.4bn to buy Liberty Global’s cable networks in Germany and Eastern Europe to create a stronger competitor against former monopoly incumbents such as Deutsche Telekom. Few analysts question the wisdom of Vodafone’s strategy to use acquisitions to bring much needed scale to the group, but many are worried that the task of integrating the new networks comes at a time of an upcoming leadership change.
Nick Read, who will replace Colao in October, is widely seen as an unproven CEO. He was appointed the group’s CFO only back in 2014 — although investors should be reassured by his experience in running the group’s British and emerging market divisions.
Rising debt
Another cause for concern is the group’s rising debt burden. The debt-fuelled acquisition of Liberty’s assets will raise net debt to roughly €50bn at the time of completion, close to the top end of management’s target range.
The Liberty deal would also mean that the business would be more exposed to slower-growing markets in Europe, which will account for more than three-quarters of its combined operating profits. Intense competition in Italy and Spain remains a cause of unease, even though trading conditions there have recently improved considerably.
Additionally, investors should take note of the growing cost of infrastructure and mobile spectrum in recent years. Vodafone hasn’t always managed to cover the dividend with free cash flow (after spectrum and restructuring costs) since the sale of its stake in Verizon Wireless in 2013, and that has put a lot of pressure on its balance sheet.
Dividends
In spite of this, management remains committed to its progressive dividend policy. Last year, dividends per share rose by 2% in euro terms to 15.07 euro cents, or 13.33p. This means that at its current share price, Vodafone has a dividend yield of 8.1% — making it one of the highest yielding stocks in the FTSE 100.
Investors should nonetheless be wary. Even after a 30% year-to-date fall in its share price, valuations don’t look cheap. Shares in Vodafone are worth 18.9 times its expected earnings this year, despite sluggish growth and significant medium-term uncertainty.