Trading at a full 44 times consensus forward earnings, Vodafone (LSE: VOD) shares are certainly priced for significant growth. But with earnings expected to fall for the third straight year when results are announced later this week, are shares in line for a major downward rerating?
Vodafone is richly valued because the company’s three-year £20bn project to improve European 4G infrastructure is finally coming to an end. As this project comes to a close, investors are expecting high-margin data usage to grow significantly. The plan appears to be working so far, with six straight quarters of increased organic sales on a constant currency basis and a 68% year-on-year increase in customer data usage.
However, expansion into emerging markets can’t hide declining sales in Europe, the group’s core market. Total revenue in the region fell 6% in the past quarter as competition increased and drove down prices across the sector. This trend is unlikely to reverse itself, which is why Vodafone is making inroads in the broadband market and launching a TV service later this year in hopes of hooking customers into high-priced bundles. All of this investment has led to £28.9bn of debt, more than 2.4 times forward EBITDA. High debt, increasing competition, dividends uncovered by earnings and declining sales in core markets are reason enough for me to believe Vodafone shares are overpriced.
The demand issue
Chilean copper miner Antofagasta (LSE: ANTO) is even more pricey than Vodafone with shares valued at 52 times forward earnings. Antofagasta has benefitted from investors fleeing to quality, as the company’s restrained growth during the Commodity Supercycle has left it with a bevy of low-cost-of-production assets and only $1bn of net debt, which came from the timely acquisition of a heavily-indebted competitor’s mine last year.
Unfortunately for Antofagasta, good management can only do so much about falling copper prices, which have given back all their gains following a short-lived rally to begin the year. Demand from China, which accounts for roughly 40% of global output, is expected to remain weak for the foreseeable future as its infrastructure-building binge peters off. Despite Antofagasta’s low-cost assets and healthy balance sheet, I don’t see shares performing well unless copper demand unexpectedly picks up.
Value for money
The recent merger of Irish bookie Paddy Power and online gambling exchange Betfair created the industry giant known rather unoriginally as Paddy Power Betfair (LSE: PPB). The market is giddy enough about the combination of Paddy Power’s infamous marketing and Betfair’s online prowess that shares are trading at 30 times 2016 earnings.
Traders may be right to be bullish as the combined group will be one of the largest online bookies in the UK, has a healthy balance sheet and both companies continued to grow revenue by double digits last year. Management is right to focus on growing online offerings as they provided 84% of operating profits last year and are a major competitive advantage for Betfair. Analysts are already pencilling-in double-digit earnings growth for the next year as an estimated £50m in cost cutting boosts the bottom line and higher combined marketing spend drives top-line growth. Shares may be richly valued, but this is one merger that makes considerable strategic sense and could end up living up to a lofty valuation.
