Qualiport

[ Wednesday, 09 June 1999 ]

Vodafone 2009?

By Bruce Jackson (TMF Googly)

Baker Street, London -- The Qualiport message board has been firing recently, as Fools from across the globe debate investment strategies. If you've got a view, go ahead and post a message. No-one is going to bite your head off, and besides, they can't see you anyway.

In one of the posts, our own pyad suggests British Telecommunications (LSE: BT.A) for the Qualiport. This is not the first time this company has been put forward. Previously, I've ignored the suggestion, much to my cost. I thought this was a staid old utility, with shrinking margins and a shrinking market share. At the same time as thinking and writing that, I was an Internet user, and my BT phone bill was soaring. If only I'd used the old grey matter and put two and two together to get 4, rather than minus 1. You live and learn.

Stock picking is not easy. Look at Marks & Spencer (LSE: MKS) for example. To many people here was a great British company, with a great record of growth, looking to expand both here and, more importantly, internationally. The world seemed like it was M&S's oyster. Yet something went wrong. Very wrong. Profits halved in 1999 and suddenly this is looking more like a recovery share than a growth share.

There's a saying within the City that "a long-term investment is a short-term one gone wrong." That's clearly unFoolish, but it at least brings a smirk to my face. If we were being unFoolish, just for a nanosecond, one could say that Unilever (LSE: ULVR) fits that bill. Anyway, with M&S in mind, I'm going to adapt that and come up with a quote of my own. This will no doubt be discussed, debated and humoured in wine bars from Baker Street to Threadneedle Street.

"A recovery share is a growth share gone wrong."

If you think about it, it makes perfect sense. What company sets out its stall to recover? What company doesn't want to grow profits year after year?

However, the Qualiport is not about identifying and investing in recovery shares. We like companies whose share prices have fallen on hard times, but not ones whose profits have fallen on hard times. There's a clear and important distinction.

Here's a few random thoughts for today...

Name this company.

Its earnings per share (EPS) have grown a total of 26% in the 5 years to December 1999. That's a compound annual growth rate (CAGR) of 4.7%. In that same time, its share price has risen by a total of 184% or a CAGR of 20.9%, and it now trades on a trailing price to earnings ratio (P/E) of 38.

Just to recap --

Earnings growth: 4.7% per annum
Share price growth: 20.9% per annum

This sort of discrepancy cannot go on forever. Something has to give. Either earnings start motoring, or the P/E -- and therefore the share price -- has to fall. In the case of this company, earnings are forecast to grow "at double digits". Will that be enough to close this gap between earnings and share price growth? One thing's for certain -- even if double digit earnings growth is achieved over the next 5 years, the share price should not grow by 20.9% per annum over that same period.

General Electric Company (LSE: GEC) announces results tomorrow -- the last set as an engineering and defence conglomerate. "New" GEC is a telecommunications and IT equipment manufacturing group. Recently, the company committed itself to achieving sales growth of 12%-14% per annum in each of the next 5 years and to a doubling of its stock market value. Presuming there's no significant issue of new shares, hence diluting current shareholders' ownership, GEC's share price will grow by a CAGR of 14.9%, if the company achieves its target. That's the sort of returns the Qualiport is looking for. Should we take the GEC management on trust and dive in?

Qualiwatch

Yesterday, Qualiwatch company Vodafone (LSE: VOD) released results to March 1999. As ever, the market leader and soon to be world leader showed excellent growth figures, with sales up 36% and pretax profits up 44%. Excellent though the results were, they were virtually bang in line with market expectations. When a company is trading on a P/E of 68, you ideally want to see estimates beaten.

These results essentially mean that nothing really has changed regarding Vodafone's valuation. I had already factored them into my calculations. I do need to get hold of the full annual report to plug the numbers into my spreadsheet. The target Qualiport buy price for Vodafone was 1000p. I'm going to raise it slightly to 1025p, to take into account EPS that just beat my estimates and the fact that time has marched forward.

Of course, the AirTouch merger of equals will change the valuation, and that hasn't been taken into account as far as my valuation is concerned. However, the companies were roughly the same size, in terms of sales and profits, and Vodafone paid a very full price, at about 80 times earnings to December 1998. So, at the moment, I'm thinking the combined Vodafone AirTouch company would have roughly the same per share valuation as just Vodafone.

One thing that did jump out at me with Vodafone's results was the growth in the UK. Now, remember that the mobile phone market is going through an unprecedented growth phrase. The Vodafone total UK customer base rose by 63% to 5.575m people. Yet sales grew by "only" 17.8% and operating profits by "only" 14.0%. Operating margins have taken a bit of a hit but are still obscenely high at 30.8%. For a company trading on a P/E of 68, these figures are slightly worrying.

Vodafone is of course more than a UK company, with its tentacles spread far and wide. The international part of the business is where the real growth is. However, the year-on-year growth of the UK market is probably a sign of things to come for the total company, although it will take a few more years yet before Vodafone reaches a degree of maturity.

There is no perfect company, and it is often easier to pick up negative aspects of a company's numbers. Vodafone is still a great company, with miles of growth to come. But we're happy to patiently sit back and wait for the price to fall to 1025p. Somewhere, sometime, my valuation and the Vodafone share price will meet. I will constantly be revising my target, hopefully upwards, so I'm not saying that Vodafone will at some stage hit 1025p. I'm saying that one day, and this could be 10 years out, the two will merge. It may be that the share price is then 4154p, and that's the price I'm happy to pay. If we're still looking at a great company, that's the time I'll buy the shares. See you in 2009, perhaps?

For more on Vodafone, check out today's new Lunchtime Fool, up every market day by 12.30pm. It's Rob again on Friday. See you on the Qualiport message board.

Oh -- that company I asked you to name? It's Glaxo Wellcome (LSE: GLXO), the pharmaceutical giant on the Qualiwatch list at 1500p.

Company  Change    Bid
DELL   -$1.70   $33.90
EMA     -0.10    12.70
IIG     +0.01     2.99
MSY     +0.11     5.37
PIZ     -0.15     8.90
RTO     -0.03     2.55
ULVR    +0.28     5.71

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