TMFDeej (99.47)

TMFDeej Top Pick - Vodafone

October 20, 2009 – Comments (5) | RELATED TICKERS: VOD

Last month I did a brief write-up on why I thought the European telecom giant Vodafone (VOD) is a good buy at this level.  A few of the things that I like best about VOD are the fact that it's cheap, unlike so many companies out there its revenue was still growing...even in the midst of a terrible recession, it pays a massive, sustainable dividend, it stands to benefit from increased smart phone use, and it has a hidden potential catalyst that I'll get to later.  It definitely is one of my top places for new money right now.

I decided to mention Vodafone again because I came across a bullish blurb (how's that for alliteration) on the company in this month's Smart Money magazine.  Here's it is for anyone who is interested:

"Vodafone Group

Vodafone is one of the most geographically diversified telecom firms, with footprints in Europe, Africa, Asia and, thanks to a 45 percent stake in Verizon Wireless, North America.  The recession hurt its business in some developed economies, such as Germans, but growth in emerging markets has more than offset the slowdown.  In the company's fiscal first quarter, which ended June 30, revenue was up 9 percent from the same period in 2008, and the company's free cash flow increased 21 percent, to $2.7 billion.  Vodafone's fat 7 percent yield is "one of the safest dividends out there," Says Michael Yoshikami, portfolio manager of the Destination Select Equity Fund, which owns shares."

I said most of what I had to say on the company back in September.  Here's the text of that post for anyone who's interested:

"A hidden potential catalyst that could cause this boring stock to soar

...I have been long VOD since January 2009 in CAPS.  The pick has done well, but it is losing in the game of CAPS because it has underperformed the S&P 500 by four points year-to-date.  The company's yield initially attracted me to it, but not enough to persuade me to invest in it in real life.

The latest positive reference to VOD came in an interview with someone who many at The Motley Fool follow, Vitaliy N. Katsenelson, author of the book Active Value Investing.  Katsenelson and the other articles all talk about a specific catalyst that could provide a nice lift to the European telecom giant's stock.  Vodafone currently owns a 45% stake of Verizon Wireless.  Verizon Wireless generates a tremendous amount of free cash flow, but it has not distributed any of this cash to its parent companies in several years.  Instead in the past it has been focusing on growing rapidly and expanding its wireless network.  Its acquisition of Alltel last year cost it $20 billion alone. 

After the Alltel acquisition, Verizon Wireless focused on paying down its massive debt load, shaving off more than $10 billion per year.  All of the positive articles on VOD that I have seen hypothesize that Verizon Wireless may resume making dividend payments to its parent companies again in the near future, throwing a ton of cash in their direction.

Furthermore, any recovery in the economies of emerging markets would be a boon to Vodafone.  In emerging markets, most people use pre-paid minutes...which they buy by the hundreds...for their phones.  When times get tough, minute sales fall off of a cliff as consumers circle the wagons and burn the existing minutes that they have already paid for.  This phenomenon caused VOD's sales of minutes in emerging markets to fall by 6% to 7%.  Eventually as the economy recovers and consumers deplete their store of minutes, they will begin purchasing them from VOD again and its results will improve dramatically.

Combine the potential for a renewed income stream from Verizon Wireless and an improvement in its core business with the fact that if one backs out VOD's 45% stake in the company, which Katsenelson currently values at $50 to $55 billion, one is able to buy the other cash-generating businesses of the company at around only seven times free cash flow, which is extremely cheap.

Add these things to the fact that the aspect of VOD that initially attracted me to this company, its 6% dividend [it's over 7% today], still exists and its is fairly attractive."

Deej