Over the past three months, shares in international telecoms giant Vodafone (LSE: VOD) have jumped by around 25%, substantially outperforming the rest of the FTSE 100, excluding dividends.
Investors seem to be returning to the company following its €18.4bn acquisition of telecoms assets across Europe from peer Liberty Global. Following the deal, Vodafone is now one of the industry’s largest on the continent, and is rapidly closing in on Deutsche Telekom, Europe’s largest telecoms group.
The Liberty deal substantially increased Vodafone’s exposure to Germany, which the company calls “the engine of Europe.” The group is now Germany’s largest pay-tv operator, with 14m subscribers, making it the second biggest pay-tv provider in Europe behind Sky.
A European giant
This size and scale gives Vodafone a tremendous advantage over the rest of the market. According to City analysts, before the deal, Vodafone had a presence in most European markets, but it didn’t have enough scale to compete effectively with the rest of the industry.
Now Vodafone has bulked up its German operations, analysts believe the company has acquired the size and scale to dominate the European telecommunications market by using Germany as a launchpad.
Vodafone is also deploying groundbreaking technologies in the country. For example, at its Düsseldorf headquarters, workers can now control robots at a factory 80 km away using 5G mobile technology. The group has also signed a flying car deal with Chinese technology company EHang in Germany.
According to analysts, all of these efforts mean Vodafone will return to growth in its 2021 financial year. After several years of stagnating or declining earnings, analysts are forecasting earnings growth of 23% in Vodafone’s next fiscal year, as the earnings benefits from Liberty Global start to flow through to the bottom line.
A big risk
However, the one area where the company still needs to make substantial progress is reducing its borrowing. As I’ve pointed out, Vodafone’s borrowings are on track to hit a staggering €55bn, excluding any asset sales. There are asset sales planned, but progress has been slow on this front.
This high level of borrowing could mean Vodafone might have to cut its dividend once again. So that’s something income investors should be aware of. Still, from a growth perspective, Vodafone’s outlook appears bright. And that’s why I believe there’s still time to pile into the Vodafone share price after its recent performance.
If you’re only interested in capital growth, and not worried about the company’s dividend sustainability, then Vodafone’s shares could be for you. As earnings growth returns, I expect investors to re-rate the stock higher, based on its brighter prospects.
Even though the stock is up 25% in just a few months, from a cash-flow perspective, it still looks cheap. Shares in the company are dealing at a price to free cash flow ratio of just 10.2, compared to the telecoms industry average of 14.6.
On top of this attractive multiple, the stock also supports a market-beating dividend yield of 5.1%.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019