August 21, 2017 / 12:37 PM / 3 months ago

Fitch Affirms Vodafone at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, August 21 (Fitch) Fitch Ratings has affirmed UK-based Vodafone Group Plc's (VOD) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook on the IDR is Stable. A full list of rating actions is at the end of the commentary. Vodafone's (VOD) ratings capture the group's well-diversified mix of telecoms operations, premium position in consumer and enterprise markets, increasing emphasis on convergent businesses and well-executed business strategy. A pragmatic approach to challenging markets, with examples including the merger in India and VodafoneZiggo JV in the Netherlands, underpins our view of management execution. Solid operational trends across the majority of consolidated businesses and scale in its core markets lead to expectations of strengthening financial performance at the earnings and operating cash-flow levels, and improving leverage. Sustained albeit more normalised capex levels, spectrum investment and a progressive distribution policy represent a significant use of cash, limiting the group's ability to generate post-distribution free cash flow. Equity proceeds from the maturing mandatory convertibles, together amounting to EUR3.5 billion allow good leverage headroom in our rating case: FFO net leverage is forecast to fall from 3.3x in the financial year to March 2017 (FY17) to 3.2x in FY19 versus a downgrade guideline of 3.5x. KEY RATING DRIVERS Sound Fundamentals, Positive Operating Trends: Data usage and convergence are driving strengthening performance, the company's "more for more" commercial strategy supporting positive ARPU and service revenue trends. Project Spring investment has helped reclaim the group's premium market positioning where customer value is greatest. Most core markets are on a positive trend and convergence is driving a strengthening revenue mix and business profile. Areas of weakness such as the UK remain, but the majority of markets are performing well. The consistency of results underpins expectations for continued growth and improving operational cash flow. Idea Merger Addresses Indian Weakness: Fitch regards the merger as positive, both for the merged entity and the wider market. Market consolidation has long been expected given too many players and a fragmented market. The merger removes what has been one of VOD's most challenging markets from the consolidation. The industrial logic is nonetheless sound and considered the primary driver of the transaction. It brings together complementary market strengths, with VOD India positioned strongly in regional circles where Idea is less so, and vice versa. It creates a substantial national market leader, reduces the number of market players and should deliver sizeable synergies. Pragmatic Portfolio Management: The group exhibits a widely invested geographic mix of increasingly convergent telecoms businesses, with strong market positions in consumer and enterprise. With core markets like Germany, Italy, Spain and South Africa performing strongly, management has shown pragmatism in seeking to resolve more challenging market environments such as India. Another example is the Netherlands where VodafoneZiggo (BB-/Negative Outlook), a JV with Liberty Global's cable operations, has created a strong convergent competitor to incumbent, KPN (BBB/Stable), and should over the medium term help promote a more rational market. Italian Market Impacts From 2018: Operations in Italy accounted for around 16% of FY17 EBITDA. A high-margin business, market stabilisation has been helped by the four to three player consolidation in 2016, with VOD recording organic mobile service revenue growth of 2.3% and strong margin expansion in the year to March 2017. The market entry of Iliad in late 2017/early 2018 is expected to re-ignite market pressures. Fitch anticipates multi-year, single-digit declines in the overall market and that Iliad will quickly gain market share approaching 10%. Pressure will be felt most by value proposition WIND/Tre, although our base case assumes that VOD and Telecom Italia will also suffer, albeit we do not envisage a material impact on VOD's ratings headroom. Improving Financials, Ratings Headroom: The growth trends established across the business and good delivery of cost efficiencies underpin Fitch's expectations of stable followed by improving operating cash flows. Capex, spectrum investment and a progressive distribution policy, provide more limited potential for free cash-flow expansion. De-consolidation of India has an estimated 0.2x negative impact on Fitch-defined metrics (spectrum liabilities already excluded from our metrics). FFO net leverage is nonetheless forecast to fall to around 3.2x by FY19 (FY17: 3.3x), benefiting from EUR3.5 billion of equity proceeds from two maturing mandatory convertibles (currently assigned 50% equity credit). DERIVATION SUMMARY VOD's natural peer group includes the large diversified European incumbent telecom operators, Deutsche Telekom (DT), Orange (both BBB+/Stable) and Telefonica (BBB/Stable), extending to incumbents with more limited scale, such as BT (BBB+/Stable), KPN (BBB/Stable) and Telecom Italia (BBB-/Stable). Compared with the large incumbent 'BBB+' rated peers VOD exhibits a well-diversified portfolio of international businesses, with geographic scope and financial metrics comparable to these peers. VOD has better diversification, with similar growth and leverage qualities to DT, and a stronger growth outlook but moderately weaker leverage than Orange. The scale and diversification of this peer cohort provide deleveraging levers (cash-flow scale, potential for asset sales or minority listings) not enjoyed by smaller operators, providing more latitude in this group's downgrade threshold (set at 3.5x across the peer-group). No country-ceiling, parent/subsidiary or operating environment aspects impacts the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - group revenue to fall by around 3% in FY18 reflecting EU roaming charge and termination rate changes; - revenues are thereafter expected to grow at low single-digit rates; - EBITDA margins gradually improving to around 32% by 2021; - capex/sales (excluding spectrum) falling gradually but remaining at 15%-16% per annum; - spectrum payments of EUR1.9 billion in 2018 and EUR2.2 billion in 2020. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -FFO adjusted net leverage falling sustainably below 2.5x -Strong free cash-flow generation with high single-digit pre-dividend free cash flow on a sustainable basis -Continued stability and improving trends across Vodafone's main operating subsidiaries would be important factors in any potential upgrade Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -FFO adjusted net leverage sustainably above 3.5x, which would lead to a downgrade -Pressure on free cash flow driven by EBITDA margin erosion, higher capex and shareholder distributions, or significant underperformance in the main operating subsidiaries may also be negative for ratings LIQUIDITY Sound Liquidity: VOD exhibits sound liquidity, including good access to debt markets, strong banking relationships and solid pre-distribution free cash flow. Fitch defined cash and cash equivalents amounted to EUR10.4 billion at March 2017 with the group benefiting from a further EUR8 billion of undrawn bank lines. Access to debt capital markets is considered competitive. FULL LIST OF RATING ACTIONS Vodafone Group Plc 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' Contact: Principal Analyst Tom Steabler Associate Director +44 20 3530 1661 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Tajesh Tailor Senior Director +44 20 3530 1726 Summary of Financial Statement Adjustments Lease adjusted debt includes the following assessment and application of Fitch operating lease criteria: Fitch has excluded lease rentals related to short term assets and LLU lines from the 2017 annual lease expense; assessed the geographic mix of leased assets and applied lease multiples of 5x (Turkey), 6x (South Africa), 7x (Romania, Greece and New Zealand), and the standard 8x (rest of world). Telecom connectivity leases attract a 5x multiple. 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