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Why the Vodafone share price could outperform the FTSE 100 this year

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Over the past year, shares of Vodafone (LSE: VOD) have slightly underperformed their FTSE 100 index, but I believe the telecoms giant could reverse this trend in the year ahead.

The main factor behind my increased optimism towards Vodafone is the group’s strong competitive position in the UK and Europe. In recent years, the company has invested well over £19bn into upgrading its networks in the Continent, which has dramatically improved data connection speed. And it has rolled out 4G coverage into a variety of new markets.

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This was an expensive capital project, but if data usage by consumers continues to rise significantly as ever more devices are connected to the internet, it will stand to reap the benefits. This is because data usage is one of the higher-margin activities telecoms firms are involved in, so the 61% year-on-year uptick in data usage by customers that Vodafone recorded in the quarter to December should be very welcome for investors.

Furthermore, as the massive Project Spring investment programme winds down, capex spend should fall back towards its historic levels. These twin factors have helped management guide for 2018 EBITDA of between €14.75bn and €14.95bn with free cash flow of around €5bn before the costs of acquiring new wireless spectrum licenses. This would be a significant improvement over the past two years.

Now, there is still significant progress that Vodafone needs to make in areas such as cost-cutting in order for investors to regain confidence in the telco. But with its shares offering a 6.3% dividend yield safely covered by cash flow, and decent growth prospects from wider trends and wise investments, I believe Vodafone could outperform its index over the next year if it finally meets investors’ expectations.

A budding dealmaker to keep an eye on 

Another company in the telecoms sector that interests me is Zegona (LSE: ZEG), which was formed as a holding company with the intention to buy, improve and sell on telecoms providers in European markets.

The group has recently completed its first such purchase, improvement and disposal cycle with Northern Spanish telecom Telecable. Zegona notched up a healthy cash return on last year’s sale of Telecable and while its post-sale equity holding in the acquirer, Euaskatel, hasn’t performed as well, with a falling share price, it still shows the management team has the necessary expertise to find suitable targets, buy at an attractive price and deliver good returns to shareholders.

The group is now looking for its next acquisition but in the meantime pays out a 7.43% trailing dividend yield thanks to cash left from the Telecable sale and cash flow from its equity interest in Euskatel. This dividend yield will naturally fall as management has returned the bulk of the proceeds of the sale to shareholders via a £140m tender offer, but there will still be continued payouts while management searches for its next purchase.

I wouldn’t buy the shares right now until the next such purchase is announced, since it will be funded through a rights offer more likely than not, but Zegona is definitely an interesting company I’ll keep watching closely.

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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