Fitch Affirms Vodafone Group Plc at 'BBB+'; Outlook Stable
Vodafone is comfortably positioned at a 'BBB+' rating. The group benefits from global scale, diverse operations and sound liquidity. Free cash flow (FCF) generation, which has been under pressure from acquisitions, network upgrades and spectrum acquisition, is expected to improve over the coming years. Leverage is expected to remain somewhat high relative to historical levels for the next two years, given the ongoing effect of these pressures. The underlying operating performance of the group is stable and improving, with the benefits of these investments evident, and some deleveraging expected beyond 2018. The company compares well with other 'BBB+' rated telecom peers and we expect it to maintain reasonable rating headroom.
KEY RATING DRIVERS
Stable Leverage and Headroom
Vodafone's FY16 FFO net leverage was 3.2x. Fitch expects this to remain broadly stable for the next two years and to decline thereafter as investment pressures are offset by strengthening cash flow. Vodafone's operations are growing in almost all of its key markets. In Fitch's view, infrastructure and other investments are helping reinforce the leading market position and network quality the company has sought through Project Spring. 2016 results included a return to underlying growth in group revenues and solid recovery in EBITDA, which was up 2.7% in organic terms compared with a decline of 6.9% in 2015. The business and operational profiles are stable, with performance in Europe solid and Africa, Middle East and Asia Pacific continuing to deliver sound underlying growth.
With the leverage forecast in our rating case, Vodafone has reasonable headroom absent any unforeseen events such as unexpected M&A.
Project Spring; Network Quality Matters
Vodafone has spent the past two years investing heavily across its global operations through Project Spring, with an emphasis on network quality intended to reinforce the company's commercial position as a market leader at the enterprise and retail levels. In Europe, 4G coverage had reached 87% at YE16; 3G coverage in India, 95%. 4G penetration and data usage are translating into improved revenues. Precise payback metrics are not easily quantified. Improvements in KPIs and the trends for both revenue and EBITDA are tangible.
Thin Cash Flow; Growth Ahead
Management is guiding the 2017 dividend, a substantial use of cash, will be covered by FCF. This was not the case in recent years given investment over the past three years; including Project Spring capex (GBP19bn) and sizeable spectrum investment (GBP7.7Bn), which together with acquisitions (GBP14.7bn) have driven leverage higher. The breadth of Vodafone's operations will always lead to periods of heightened investment, while sizeable spectrum acquisition is an ongoing feature. Management guidance for capex to sales suggests a structurally higher level of capital intensity. In Fitch's view, Vodafone's scale and operational strength provide management with flexibility to invest for the long term, with FCF performance which has been somewhat weak for the rating, expected to strengthen over the coming years.
Convergent Footprint; Hybrid Infrastructure Strategy
Vodafone had increased the number of high-speed broadband homes passed with owned infrastructure to 30 million by March 2016 up from 14 million at September 2013, with a further 42 million homes covered via fixed line wholesale access; in total providing fixed access coverage to 48% of homes in Europe. Over the same period it has nearly doubled its fixed broadband base to 13.4 million from 6.9 million. The group combines a hybrid approach to fixed coverage, in markets like Germany and Spain for instance owning its network infrastructure; in Italy and the Netherlands conversely taking a partnership approach to convergence. We believe the ability to offer converged services is particularly important in enterprise, which accounts for 35% of Vodafone's European revenues and where underlying fixed service revenue growth is currently outpacing mobile.
Convergence has proven to have clear churn benefits, which is evident in Vodafone's European operations; along with mobile back-haul benefits. Strategic alliances such as those in the Netherlands and Italy, underline a pragmatic approach. Management understands the need to offer a converged solution, regardless of network or business ownership. We view execution risk as higher in Italy, with few if any examples of large scale network deployments using electric utility ducts and poles so far. Nonetheless, project logic is sound, while Vodafone otherwise maintains wholesale access to the incumbent network on reasonable terms.
Liberty Global Event Risk
Fitch treats a wider consolidation with Liberty Global as event risk. Management at both companies have acknowledged the industrial logic of a transaction; with differences reflecting views of valuation and balance sheet leverage. For the time being, both groups appear to be taking a pragmatic approach to ensuring convergent service capabilities in terms of their respective business strategies. Vodafone introduced a change of control put to its bond (EMTN) documentation in January 2016; although with no retroactive effect it will take time for the provision to have a wider impact on a GBP22bn bond portfolio. All issuance under the revised documentation includes the put, with the group so far issuing bonds with a nominal value exceeding GBP8bn including the provision. In Fitch's view, the move acknowledges the importance management attach to creditors' concerns.
Well Positioned Among Peer Group
Vodafone's operating profile compares well with the large European incumbents, in terms of scale, breadth of operations, cash flow diversification, growth potential and increasingly so in terms of its diversified service platform. An FFO net leverage downgrade threshold for the large European telecom peer group is broadly set at the 'BBB+' level at 3.5x. Fitch's approach is to rate to sustainable leverage, where relevant looking through near-term cash flow weakness and heightened leverage. Vodafone's YE16 metric of 3.2x in any event compares well among its peers; Orange (3.3x), Deutsche Telekom (3.7x) and Telefonica (3.7x) all at YE15.
Fitch's key assumptions within the rating case for Vodafone include:
- Low-single digit group revenue growth over the next three years reflecting a continued stabilisation of service revenues in Europe and mid-to-high single-digit service revenue growth in Africa, Middle East and Asia Pacific.
- Group EBITDA margins gradually improving to 30% by 2020.
- Capex/sales (excluding spectrum) of around 15% per year from FY17 onwards.
- Spectrum payments of EUR2.5bn in FY17 with further significant payments in FY20.
- 50% equity credit applied to the company's mandatory convertible bonds
- Share buybacks matching Verizon loan note receipts
Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage sustainably above 3.5x (FYE16: 3.2x), which would lead to a downgrade.
-Pressure on FCF from EBITDA margin erosion, higher capex and shareholder distributions, or significant underperformance in the main operating subsidiaries.
Future developments that may, individually or collectively, lead to positive rating action include:
-FFO adjusted net leverage falling sustainably below 2.5x.
- High single-digit pre-dividend FCF margin on a sustained basis.
- Stabilisation of operating performance across Vodafone's main operating subsidiaries.
Vodafone has considerable liquidity. As at March 2016, the group had GBP10.5bn of unrestricted cash and cash equivalents (according to Fitch methodology) and access to approximately GBP6.0bn of dollar and euro denominated undrawn RCFs (EUR4.0bn maturing March 2021 and USD4.1bn maturing February 2021). We believe that Vodafone has good access to the capital markets to refinance upcoming bond maturities as required.
FULL LIST OF RATING ACTIONS
Long-Term IDR: affirmed at 'BBB+'; Outlook Stable
Senior unsecured rating: affirmed at 'BBB+'
Short-Term IDR: affirmed at 'F2'
Commercial paper programme: affirmed at 'F2'