The Long and Short
Vodafone looks better than US peers
Meredith Contente | June 2, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
As Vodafone Group PLC (VOD: Baa2/BBB(p)/BBB) begins its transformation toward a leaner organization with a portfolio sized for growth, its balance sheet remains strong with potential to get stronger. VOD shows better leverage and stronger adjusted EBITDA margins compared to its US wireless peers. Asset dispositions and a new joint venture have significantly reduced debt and added cash to reinvest in its transformation. A stronger balance sheet could lead to ratings upgrades, particularly at S&P, where the agency has a positive outlook on the current ratings.
While VOD’s US peers AT&T Corp (T – Baa2/BBB/BBB+) and Verizon Communications (VZ – Baa1/BBB+/A-) also remain in debt reduction mode to achieve their respective leverage targets, VOD is already at the low end of its target range. That said, VOD’s USD bonds could collapse closer to its peers across the pond. VOD spreads begin to dislocate from peers in the 10-year part of the curve and beyond (Exhibit 1). A swap out of T 5.25% 2037 or VZ 5.25% 2037 into VOD 6.15% 2037 provides for a pick of 22 bp and 32 bp, respectively.
Exhibit 1. VOD Curve vs. US Wireless Peers (T & VZ)
Potential S&P Upgrade
S&P placed VOD’s rating on positive outlook subsequent to the company’s announcement that it was looking to create a joint venture to co-control its 81.7% stake in Vantage Towers. The joint venture was completed in the fourth quarter of 2022, in which VOD received EUR4.9 billion in net proceeds from the partner consortium led by KKR and Global Infrastructure Partners for a 25% stake. There remains an option for the partner consortium to increase their ownership in the joint venture to 50% (by June 30, 2023) which could bring in more proceeds for VOD. Post close of the joint venture, S&P fully deconsolidated Vantage Towers debt from VOD’s balance sheet given the equal voting rights with consortium, which reduced net debt by EUR 2.2 billion. Free cash flow will benefit as VOD will no longer finance Vantage Tower’s growth capital expenditure investments, however that benefit will be more than offset by restructuring costs. Furthermore, the agency noted that the creation of the joint venture does not materially weaken VOD’s business profile.
S&P believes the maintenance of S&P adjusted leverage below 3.0x could warrant an upgrade over the next 18 months. Given management’s explicit commitment to maintaining net leverage at the low end of its guidance range, that should provide VOD with sufficient headroom under the higher BBB+ rating, a requirement for S&P to raise the rating. VOD has reduced net debt over the past year by a total of EUR 8.2 billion with the joint venture and proceeds from the sale of the company’s Hungary business.
VOD Leverage Target Already Achieved
VOD ended the year with net leverage of 2.5x, which was down two ticks from the year-ago period. VOD reduced net debt over the past year by a total of EUR 8.2 billion with the joint venture and proceeds from the sale of the company’s Hungary business. Management noted on the earnings call that they are comfortable with keeping leverage at 2.5x given the overall macro environment. In comparison, T’s net leverage currently stands at 3.2x, versus a net leverage target of 2.5x. T has guided that it plans to achieve its net leverage target by early 2025. VZ continues to maintain a net leverage target of 1.75x-2.0x, however net leverage currently stands at 2.7x. VZ’s net leverage target could take years to achieve as excess free cash flow that could be used for debt reduction is minimal.
Liquidity Strong Heading into Transformation
VOD ended the year with total cash on hand of EUR 11.7 billion coupled with approximately EUR 7.7 billion of availability under its credit facilities. While full year guidance is calling for a decline in adjusted free cash free cash flow, the bulk of the reduction is largely due to the joint venture and asset disposition. Excluding those one-time items, adjusted free cash flow will only be down roughly EUR 500 million from the year-ago period, reflecting restructuring costs. We note that VOD’s free cash flow guidance includes dividend payments.
That said, VOD remains in a position to tackle upcoming debt maturities with cash on hand in this rate environment. VOD has EUR 879 million maturing in 2023 and EUR 2.7 billion maturing in 2024. We anticipate that VOD will look to a combination of debt reduction and refinancing in order to keep net leverage at the 2.5x level. Management noted that it will take a longer time to have another organic step down in leverage. Any additional proceeds that may be derived from asset sales or the joint venture will likely be used to fund a combination of increasing shareholder value and debt reduction.