The Vodafone (LSE: VOD) share price has continued to underperform the market over the past few weeks. The stock registered a small bounce between the beginning and last week of November, but it has since resumed its decline.
Following this performance, shares in Vodafone have fallen 14%, excluding dividends over the past 12 months. By comparison, the FTSE All-Share Index has returned 13% over the same timeframe. This implies that the stock has underperformed the broader market by 27%, excluding dividends.
Vodafone share price drop
Shares in the company dropped in November after it reported its fiscal first half 2022 results. The figures showed a 22% decline in operating profit, although overall group service revenue increased by 2.8%. Cash generated by operating activities increased 7.4% in the period.
These numbers were not particularly inspiring. Operating profit slipped due to higher capital spending costs and a lack of lucrative roaming fees. Free cash flow generated by operating activities also collapsed.
The company’s adjusted free cash flow for the period totalled €23m, down from €451m in the prior-year period. Net debt increased by 0.9% to €44.3bn.
According to the corporation, cash flow will be weighted to the second half. Management is guiding for adjusted free cash flow of €5.3bn for the current financial year.
If Vodafone hits this projection it may be able to make a dent in its debt pile, which is one of the company’s biggest challenges. Management is focusing on getting debt under control and has been selling off assets to try and streamline the business.
Until the company can make a material dent in its debt mountain, I think the market will continue to give the business a wide berth. Without a strong balance sheet, Vodafone may struggle to make the investments required to stay ahead of its competition.
The firm may also have to cut its dividend if it suffers a sudden decline in profitability, as paying off debt holders is far more important than rewarding shareholders.
Challenging outlook
Put simply, it looks as if the market is avoiding the Vodafone share price because of the company’s weak balance sheet and declining profitability.
If the organisation hits its free cash flow targets for the year, it may be able to reduce debt, and this could help improve investor sentiment. As the economic recovery starts to gain traction, the company’s profits may also recover, which would only enhance investor sentiment further.
As such, I am cautiously optimistic about the outlook for the Vodafone share price. That is why I would buy the stock as a speculative position for my portfolio today.
If the company can capitalise on the economic recovery, reduce debt and cut costs, earnings will recover, and the market may rerate the stock to a higher growth multiple. On the other hand, if the group continues to struggle, the stock may continue to underperform the market.
