Vodafone '12 Hurt by Weak Europe

British mobile phone giant Vodafone Group Plc (VOD - Analyst Report) reported adjusted earnings of £0.1491 per share (or earnings per ADS of $2.38) for fiscal 2012 (ended March 31, 2012). The earnings missed the Zacks Consensus Estimate of $2.51 and decreased 11% from the last year.

The lackluster results were due to higher taxes and weaker operations in Europe. Profitability at Vodafone was impacted by its strategy to exit minority holdings. These included the sale of stakes in the French joint ventureSFR, Poland’s Polkomtel, China Mobile and the Japanese wireless operator Softbank Corporation.

Consolidated revenue inched up 1.2% year over year to £46.417 billion ($74.109 billion), outpacing the Zacks Consensus Estimate of $73.178 billion. The outperformance was driven by increased data services and market penetration of voice services in emerging markets. The growth was partially offset by regulatory issues, ongoing competitive pressures and challenging economic conditions.

More than half of the revenue growth was organic (up 2.2%) and came largely from emerging markets. Group service revenue (93.1% of total revenue) grew 0.3% (1.5% on an organic basis) year over year to £42.885 billion ($68.47 billion).

Consolidated data revenue climbed 22.2% to £6.23 billion ($9.95 billion). Messaging and fixed-line revenue increased 3.8% and 6.3% to £5.28 billion ($8.42 billion) and £3.62 billion ($5.78 billion), respectively. Other service revenue was £2.06 billion ($3.29 billion) in 2012, up 7.6% year over year. However, voice revenue dropped 5.6% to £25.69 billion ($41.02 billion).

Adjusted operating profit fell 2.4% year over year to £11.532 billion ($18.41 billion) in 2012. Organically, it grew 2.5% on strong performance by Verizon Wireless.

Segment Results

Europe

Revenues for the European segment grew 0.5% year over year and slipped 0.1% on an organic basis to £32.181 billion ($51.38 billion). Service revenue in Europe also slid 0.6% and 1.1% organically to £29.91 billion ($47.75 billion) as growth in Germany, the UK, the Netherlands and Turkey was offset by declines across southern European markets, in particular Italy, Spain and Greece.

Africa, Middle East and Asia Pacific

The Africa, Middle East and Asia Pacific revenue climbed 4.2% and 8.4% organically year over year to £13.87 billion ($22.14 billion). Service revenue increased 8% year over year on an organic basis, driven by strong data and subscriber growth in India, Vodacom, Ghana and Qatar, and return to growth in Egypt that was partially offset by weak performances in Australia and New Zealand.

Subscriber Trends

During the fourth quarter, Vodafone added roughly 6.6 million new mobile connections across its operations, bringing the total subscriber base to 404.69 million (80.5% represented by prepaid). Vodacom continued to be a key driver of subscriber growth with net addition of 4.37 million customers, contributing 62% to total net addition in the Asia Pacific & Middle East segment.

In Europe, the company lost 1.41 million subscribers, bringing the region’s total customer base to 148.5 million at the end of March 2012. Africa, Middle East & Asia Pacific added 8.0 million customers, taking the total subscription to 256.2 million.

Liquidity

Vodafone’s net debt reduced to £24.42 billion at the end of fiscal 2012 from £29.86 billion at the end of fiscal 2011.

The company generated free cash flow of £6.1 billion, down 13.4% year over year but within the guidance range of £6.0–£6.5 billion. Capital expenditure increased 2.3% year over year to £6.36 billion.

Dividends

During 2012, Vodafone paid a special dividend of £0.04 per share to its shareholders, including the dividend of Verizon Wireless, a joint venture between Vodafone and Verizon Communications Inc. (VZ - Analyst Report).

The company will pay a final dividend of £0.0647 on August 1, to shareholders of record as of June 8. The dividend represents a 7.0% increment year over year, marking the company’s target of minimum 7% dividend growth per annum by March 2013.

Guidance

Vodafone issued its fiscal 2013 guidance. Management expects consolidated EBITDA margin decline to improve due to continued healthy growth and operating leverage in Africa, Middle East and Asia Pacific, and improving cost control in Europe. Adjusted operating profit is expected in the range of £11.1 billion to £11.9 billion.

Free cash flow is expected to remain stable in the range of £5.3 billion to £5.3 billion, excluding any dividend received from Verizon Wireless.

Our Take

Coupled with successful smartphone and data services adoption, we believe Vodafone is well positioned for the upcoming year through the expansion into emerging markets such as Eastern Europe, Asia, India and Africa as well as enlarging growth in enterprise segments. Additionally, the company will continue to focus on increasing rewards to its shareholders.

Nevertheless, Vodafone continues to face declines in service revenue and subscriber count, particularly in Italy and Spain, due to weakness in the economy, a harsh regulatory backdrop and stiff competition from larger rivals like Verizonand AT&T Inc. (T - Analyst Report). Reductions in mobile termination rates would also pose a major threat to the stock.

We are currently maintaining our long-term Neutral recommendation on Vodafone. For the short term (1–3 months), the stock retains a Zacks #3 (Hold) Rank.