Morningstar equity analysts have upgraded their fair value estimate for Vodafone (VOD) shares to 255p from 240p as the telecommunications firm managed to reduce costs faster than expected.
In first-half results published on Tuesday, the company said it had generated profit margin of 32% versus our full-year projection of 30.5%. This improvement was faster than we expected though we anticipate it will reduce next year when Vodafone’s rival Iliad enters the Italian market. We then anticipate profit margins to start expanding again in the 2020 financial year.
The company said on Tuesday it would raise its full-year profit guidance to 10%, higher than the 4-8% growth previously pencilled in, and the shares rose 5% to 227p, still below Morningstar’s fair-value estimate of 255p.
The firm’s revenue fell 4.1% year on year versus our full-year projection of a drop of 2.2%. However, service revenue increased 1.7% excluding currency movements. We had already factored in some currency declines, but they were worse than we anticipated, particularly the Turkish lira and the Egyptian pound. That said, we are pleased with Vodafone’s service revenue growth in most countries. The main exception being the UK where organic revenue declined 2.8%, but even here revenue would have been close to flat without the European Union’s “Roam-Like-At-Home” plan that removes termination charges when customers use their phones in other European countries.
Worldwide, Vodafone grew its wireless subscriber base 4.1% from the year-ago period to 275.4 million, excluding discontinued markets in India and the Netherlands where mergers have caused the firm to split out its operations. However, pricing has been squeezed in many markets.
Vodafone also grew its broadband base 9.4% to 15.4 million. Increasingly, its broadband customers are also taking Wi-Fi on their mobile phones, which is helping its rate of customer defection. We expect convergence, where customers take multiple telecoms products from the same provider, will continue to provide opportunities for growth.
Vodafone's Competitive Advantage
Vodafone is one of the largest wireless phone companies in the world, with 264.9 million customers excluding India and networks across the world. Where it doesn't have its own operations, it has formed strategic partnerships. More important than its global size is the scale it has within its various markets and the quality of those networks. Thanks to Project Spring, the quality of the firm’s network is almost always in the top two, allowing it to compete more on quality than on price.
As telecom networks are expensive to build and maintain, the more customers an operator has on its network, the more people it can spread its fixed costs over, thus reducing the average cost per subscriber. Vodafone’s scale also provides it with some advantage over competitors, allowing it to source equipment at lower prices. The firm can develop a product in one country and roll it out to others at minimal additional expense.
Thanks to Vodafone's scale, it can afford to bid for more spectrum, or mobile coverage, which improves the quality of its network, thereby attracting more valuable heavy data users. The high costs of building and maintaining a network tend to limit the number of operators in a country, which leads to efficient scale. We believe Vodafone has a narrow economic moat, or slender competitive advantage, as a result of cost advantages from its size and from efficient scale.
