Analysts Debate: Is Vodafone a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Vodafone (Nasdaq: VOD  ) , the international wireless provider.

Vodafone by the numbers
Here's a quick snapshot of the company's most important numbers:

Statistic

Result -- Fiscal 2012

Revenue

$74.2 billion

Net Income

$11.2 billion

Market Cap

$142.5 billion

P/E Ratio

13.1 trailing, 11.0 forward

Dividend Yield

6.8%

Mobile Customers

446.5 million

Key Competitors

AT&T (NYSE: T  ) , T-Mobile,  Airtel 

Sources: Company filings.

Travis' take
Vodafone is an international mobile network operator with access to some of the most desirable locations in the world. Vodafone and Verizon (NYSE: VZ  ) are equity partners in Verizon Wireless, with Vodafone owning 45% of the wireless giant. The company also owns the second largest network (by subscribers) in India, the largest network in Germany, and the largest network in Egypt.

European business has been hurt by the financial crisis playing out there, but emerging markets are continuing to grow. If Europe's economy stabilizes and returns to "normal," the company should grow along with it. But I want to focus on Verizon Wireless, which generated 42.2% of the company's adjusted operating profit last quarter .

When Apple (Nasdaq: AAPL  ) released the iPhone 5, I took a step back to consider who the big winners were. The more I thought about it, the more I thought that Verizon Wireless was a clear winner in the U.S. because of its superior network and ability to charge a premium as a result.

Over the past two years I've personally tested every major wireless network by accident. I'm an AT&T user for my current iPhone and have never been impressed by the network. I also bought a MiFi device from Virgin Mobile over a year ago, which works on Sprint's network. It was OK, but when I lost the device I went in search of a better experience. For some reason I chose a 4G device from T-Mobile, the biggest mistake I've ever made in electronic devices. Since I use my MiFi for work, I can justify spending a few extra dollars for something that's going to work when I need it, so I sucked it up and spent the money on a Verizon Wireless MiFi. They're expensive, but the performance puts the other networks to shame.

I think many consumers will go through the same thought process when picking their next smartphone devices for a few reasons. First, coverage has always been important and Verizon Wireless has the best network in the U.S. But the big change in newer devices is the ability to use them as hot spots. This is a huge bonus for the average user, and if you're connecting multiple devices it will be worth considering the network, more so than when phone calls were the most important thing.

For carriers, this has a few implications. 4G will increase data usage and so will the ability to connect other devices. As a 3G user, I may have used 250 MB of my mobile plan, but 4G will likely push that closer to 1 GB. Add in the hot spot ability and I may push 3 GB to 4 GB. The tiered pricing plan will make this usage more lucrative for carriers.

Vodafone is in prime position to benefit from emerging markets, a European comeback, and Verizon Wireless' dominance in the U.S. The stock is reasonably valued at 13.1 times trailing earnings and while the high dividend may fluctuate with Verizon Wireless' special dividend, I think it will still be a strong payout. I'm comfortable with an outperform call at the current price.

Sean's take
As should come as no shock to anyone who has followed my mode of thinking before, I'm not exactly in agreement with Travis or my cohorts. I know, I know... it's hard to believe, but compose yourselves!

Let's start with the highly touted Verizon Wireless. Speaking not as a loyal AT&T customer, but as an unbiased and objective investor, while the iPhone 5 will undoubtedly bring in numerous new customers since its 4G LTE is light-years ahead of its peers, the iPhone 5 is also a margin killer and could actually have an even larger negative impact on both Verizon's and Vodafone's bottom lines than previous versions did. Here's a quick glance at what gross margins have done over the past seven years at Vodafone -- and it isn't pretty!

Year

2006

2007

2008

2009

2010

2011

2012

Gross Margin

41.8%

39.8%

38.3%

37%

33.8%

32.8%

32%

Source: Morningstar. 

With consumer spending growth slowing dramatically in recent months, I'm expecting data upgrades, where Verizon Wireless makes its bread-and-butter profits, to be moot at best.

Then there's the case for European growth -- or should I say the lack thereof. In previous quarters, growth from emerging markets has been strong enough to cancel out weakness in its European operations, but that finally caught up with the company when it reported its results in July. India is showing signs of promise, but looking at things realistically, the EU's extraordinarily high levels of unemployment and its debt issues are years, perhaps even a decade, from being fully addressed. It's going to be a long time before spending picks up, and a good chunk of Vodafone's business is still tied to Europe.

On a valuation call I can't say that I'm overly excited about Vodafone either. Let's be clear that I'm not ready to bet against Vodafone right here, right now, but I feel there are certainly better alternatives. I would personally avoid the EU altogether, but if I were forced to choose, I'd prefer to own France Telecom (NYSE: FTE  ) . Even knowing that France Telecom is planning a dividend cut, it should ultimately still be yielding more than Vodafone, and has more upside to offer at seven times forward earnings as opposed to Vodafone at 11.

To me this appears to be an easy stock to avoid. I understand it's difficult to pass up a high yield and the lucrative Verizon Wireless-Apple pact, but the gross margin figures and weakness in Europe spell out a scenario that I'd rather not have any part of.

Alex's take
Sean's table of compressing gross margins got me thinking about Vodafone's free cash flow, which should be a better way to depict the company's progress over time than its highly variable (and more easily gamed) net income line. Vodafone was tremendously unprofitable for several years last decade, but its free cash flow held up. How has its free cash flow margin (free cash flow as a percent of revenue) held up as Vodafone's expanded its reach? Not particularly well. Its dividend payments have become larger than seems prudent as a percentage of cash flow in the past two years:

Year
Free Cash Flow
FCF Margin
FCF Dividend Payout Ratio

2006

$6.69 billion

22.7%

41.2%

2007

$5.82 billion

18.6%

118.1%

2008

$5.76 billion

16.3%

63.3%

2009

$5.25 billion

12.8%

79.6%

2010

$6.09 billion

13.7%

68.9%

2011

$3.36 billion

7.3%

142.7%

2012

$4.90 billion

10.6%

141.6%

Source: Morningstar.

When you look at Vodafone's dividend payments over the last few years, you'll notice that this period of high payout ratios corresponds to the point when management decided to keep payments consistently high. Rather than goose the stock, all it's done is keep it tracking the S&P 500:

VOD Dividend Chart

VOD Dividend data by YCharts.

And this is happening during a time of moderate declines in free cash flow and marked declines in the company's free cash flow as a percentage of its revenue. Investing in Vodafone with the expectation that its dividend will stay this high would be short-sighted, to say the least.

According to Vodafone's own filings, its customer base has expanded from 171 million customers in 2006 to 404 million in 2012, with 150 million of those in India. Each customer contributed $39 to Vodafone's free cash flow in 2006, but only $12 in 2012. This seems like a great strategy if your goal is to become a less-efficient company. As an investment, it's less appealing. I'm going to pass on this one. I wouldn't short Vodafone, but I don't see it as a long-term outperformer based on these numbers.

The final call
Outside of a bullish view from Travis, we have a very apathetic view of Vodafone right now. The potential value and high dividend are enough to keep us from making an underperform call, so we'll stick on the sidelines on this one.

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Fool contributors Sean Williams and Alex Planes have no positions in the stocks mentioned above. Fool contributor Travis Hoium manages an account that owns shares of Apple and Vodafone. You can follow Travis on Twitter at @FlushDrawFool, Sean at @TMFUltraLong, and Alex at @TMFBiggles.

The Motley Fool owns shares of Apple and France Telecom (ADR). Motley Fool newsletter services recommend Apple, France Telecom (ADR), Vodafone Group Plc (ADR), and Vodafone Group Plc (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 17, 2012, at 8:56 AM, rw1270 wrote:

    Another article with wrong dividend. Mindblowing.

  • Report this Comment On October 17, 2012, at 9:17 AM, rw1270 wrote:

    To clarify: Vodafone pays semiannual dividend that is not equal in amount (quite common practice in UK), but many US websites mindlessly annualize last payment. So according to these geniuses between Fabruary and August Vodafone has 3.5% yield and between August and February, the yield "skyrockets" to 7%+ - year after year. True Vodafone regular dividend yield is around 5% now, but small brains of US-based investor websites creators cannot comprehend that payments can be unequal by plan, so annualizing last payout is simply wrong.

    To make it even more interesting, Vz Wireless paid dividend last year to its parenst (VZ and VOD), from which most was passed to VOD investors. Verizon is playing mindgames with VOD for some time now and is witholding Wireless payment announcement (which everybody is expecting due to VZ unsustainable, without payout from Wireless, level of dividend - but they want to make VOD's management life harder by announcing the payment after VOD annual report.

    Anyway - none of these facts are mentioned, especially special dividend, which tells me the authors put together some figures from the Internet without backchecking and parsing VzWireless cash flow component (on both receiving and outgoing ends), which makes the article useless.

    Not to say there are no problems, but nearly 150% FCF figure is greatly excaggerated. Plus, VOD still is divesting minority stakes (their stated goal is to divest all minority but VzW), which in turn brings more cash and possibly bridges the gap for time being.

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