Super Stocks! What the StockRanks are saying about BT and Vodafone

One approach I sometimes take when looking for investment ideas for further research is to look at the average StockRanks for each sector of the market. You can find sector stats here.

Over the years, I’ve found this can sometimes highlight interesting themes, such as cyclical shifts and macro opportunities.

Recently, I noticed that the Telecoms sector currently boasts the highest average StockRank in the UK market. Consumer Defensives were in second place:

I may return to the Consumer Defensive sector in the coming weeks. But in this piece I want to take a look at telecoms – and more specifically, the two top-ranked UK telecoms stocks:

I was a little surprised to see these firms ranking so highly. Vodafone (LON:VOD) and BT (LON:BT.A) have rightly become bywords for destroying shareholder value over the last decade. While I think the problems they have faced have often been sector-wide as much as company specific, the outcome has been poor:

Even including dividend income, total returns from BT and Vodafone are negative over the last decade – and a long way behind the FTSE 100.

Incidentally, while I often hear investors comment on the high yields these stocks have provided, the reality is that both have cut their dividends by c.50% in the last five years:

In contrast, total dividend income from the FTSE 100 has risen. Even generous dividends haven’t been a great reason to hold shares in BT and Vodafone.

However, I think this situation could be changing, so I’m very encouraged to see the StockRanks supporting a more positive view.

Are telcos the new defensives?

Interestingly, I found that Telecoms was also the top-ranked sector in most other regions on Stockopedia; Europe, Developed Asia, the United States and Canada. I think there are some macro themes at work here, in addition to company-specific factors:

• Mobile and broadband services are fast becoming near-equivalent to traditional utilities – try living or working without an internet connection;

• As far as I can see, most telecoms network operators are unlikely to be heavily exposed to US tariffs or global trade disruption;

• In the UK at least, the regulator’s attitude towards further consolidation seems to have softened, in recognition of the capital intensity of these businesses and their limited pricing power. Telcos are hoping that the EU regulator may follow suit by accepting deals that reduce the number of network operators in a country from four to three.

Vodafone, BT and a fair number of other European telcos have looked like value traps for many years. The combination of competitive pressure, high capital expenditure and high levels of debt has left them unable to earn sufficient returns on the capital employed in their businesses.

Last year, Vodafone gained approval to combine its UK business with rival Three. That will reduce the number of physical mobile network operators in the UK to three. Both companies believe the deal will improve its returns on capital, despite a regulatory commitment to invest £11bn in the combined network.

I think telcos could become more defensive and less cyclical than they’ve been in the past. The go-go dealmaking days of the late 90s and early noughties are over.

This is now a mature, regulated and capital-intensive industry that needs to persuade investors to commit long-term capital at reasonable cost. That could be difficult unless these businesses can start to earn real returns above their cost of capital.

BT and Vodafone have both struggled to achieve this, but both now have CEOs who are aggressively committed to rectifying this issue:

In the remainder of this piece, I’ll drill down into the StockRanks to understand why Stockopedia’s factor-based ranking algorithms have such a favourable view of these shares at the moment.

StockRank overview

Let’s start with a look at the StockRanks and individual factor ranks for each company:

My initial impression here is that these high StockRanks are being driven by momentum first, value second and quality third. That’s not surprising given the profitability issue I highlighted above.

This means that at first glance, the investment thesis here seems to be that strong momentum and an affordable price tag could prompt a re-rating, if these firms can deliver some improvement in their quality metrics.

Quality

Vodafone’s main quality metrics highlight some of the characteristics that have held back shareholder returns for so long:

A respectable-sounding operating margin of 14% contrasts with a dire return on capital employed (ROCE) of just 3.9% – almost certainly below the group’s cost of capital.

This combination of decent margins and low ROCE highlights the capital intensity of this business. Vast investment is required to make any money at all – and those network assets then need regular upgrades.

A legacy of big acquisitions doesn’t help – removing €25bn of goodwill from Vodafone’s balance sheet improves ROCE to 5%.

It’s a similar story for BT, although the figures are slightly better:

F-Score: most quality metrics are inherently backwards looking – they reflect a company’s past accounts.

The Piotroski F-Score is slightly different because it is based on year-on-year comparisons of different quality measures. To pass each of the nine tests, the result for the last 12 months must be better than that for the prior 12 months.

This means that the F-Score does have a momentum element, albeit still historical.

Happily, both Vodafone and BT have very strong F-Scores at present, which does seem to support the view that their financial performance is improving:

Net debt: like utilities, large telcos tend to carry a lot of debt. In my view, Vodafone and BT have both carried a little too much debt in recent years. However, while BT’s net debt has continued to edge higher, Vodafone’s has fallen (helped by disposals):

One way of gauging leverage here is to compare net debt to the value of each group’s fixed assets, which I think can be seen as a rough proxy for income-generating capacity. On this measure, BT’s leverage is significantly higher, in part due to its hefty pension deficit contributions:

• BT net debt/net fixed assets: 70%

• Vodafone net debt/net fixed assets: 55%

In fairness, BT CEO Alison Kirkby says that capex has now peaked the group’s fibre rollout. She expects BT’s (adjusted) free cash flow to double over the next five years, which could create capacity for debt reduction and dividend growth.

Overall, I think it’s reasonable to suggest that BT and Vodafone are showing early signs of improving quality. The key test for me will be whether they’re able to achieve improved returns on capital and start generating value for shareholders, rather than eroding it.

Value

Even a low-return business has a price below which it becomes too cheap. Have Vodafone or BT reached that point?

There are certainly some signs of value emerging in my view, especially at Vodafone.

Vodafone: this business now trades at a massive 65% discount to its book value and broadly in line with its tangible book value.

Even Vodafone’s puny 4.3% return on equity (book value) could be attractive at such a big discount. Theoretically at least, buying the shares at this level should give a return on shareholder cost of equity of 12.3%. In other words, the company’s net profits would be 12.3% of the price paid for the shares.

However, it’s worth remembering that Vodafone is still paying full price for its capital assets and other business expenses. So unless its profitability improves, there’s still no reason for the shares to re-rate closer to their book value. This could remain a value trap – albeit the StockRanks are signalling a more positive outlook.

It’s a similar story for other key value measures I use:

• Earnings yield (EBTI/EV): 7.2%

• Dividend yield: 6.4%

Both of these are relatively attractive in my view, but only because the equity is trading at such a large discount to book value. Maintaining an attractive dividend yield at a higher valuation would require a significant increase in profitability, for example.

BT: the UK’s largest mobile and broadband operator does not look quite as cheap as Vodafone.

BT’s price/book ratio is inflated by the £4.4bn pension deficit shown as a liability on its latest balance sheet. Stripping this out would see the stock trading broadly in line with its book value.

Based on the group’s trailing 12-month return on equity of 5.9%, a P/B of 1 makes BT look considerably more expensive than Vodafone.

However, one key difference is perhaps that BT’s dividend has already returned to growth. Last year’s dividend was increased by 3.9% and the interim dividend for the current year was lifted by 4%.

If this rate of growth can be maintained (safely) then it could help to support a gradual re-rating, while maintaining a reasonably attractive dividend yield.

On balance, I think BT and Vodafone both look quite affordably valued at the moment. But the case for a re-rating depends heavily on improved profitability. Without this, in my view, a higher share price will not necessarily be sustainable.

For what they are worth, analysts’ price targets for BT and Vodafone also suggest that the latter could be trading at a bigger discount to fair value at the moment:

Momentum

Sub-par profitability is only one of the problems that’s affected BT and Vodafone over the last decade. The other is simply a lack of growth.

This has been seen both at the top line…

… and at the bottom line:

Ultimately, this situation has to improve to justify a sustainable, higher valuation for either business.

A MomentumRank of 80 (Vodafone) and 85 (BT) suggests that there may be some signs of hope. However, I’m not completely sure how compelling the evidence is. Let’s take a look at the two elements of momentum, price and earnings estimates.

Earnings estimates: the analyst consensus chart for Vodafone suggests that a significant step up in earnings is expected in the current (FY26) financial year. However, the trend is downwards and the level of growth expected has been shrinking:

Over at BT, the picture is arguably a little weaker. Little in the way of earnings growth is expected in the FY26 year. Analysts’ estimates have been volatile and have drifted lower over the last six months:

Price momentum: the picture is reversed when we consider price momentum metrics. BT looks significantly stronger than Vodafone on most key measures:

These metrics reflect the companies’ contrasting share price performance over the last 12 months:

Conclusion

The StockRanks suggest both Vodafone and BT could statistically fit the profile of good, improving businesses. While there is no guarantee that an individual Super Stock will outperform, in aggregate shares that fit this style have historically done well:

At the same time, my subjective view as someone who has followed both companies for a number of years is also that they appear to be executing well, addressing key issues and positioning themselves to deliver improved performance.

I’m encouraged to see that my subjective view is now broadly aligned with the StockRanks’ more objective and factor-driven view. That hasn’t always been the case for these two companies and I’ll admit that I’ve been too early to both of these stories in the past.

Will it be different this time? I’m not sure.

Of the two companies, I am more attracted to Vodafone because it lacks BT’s cash-hungry pension deficit, has an attractive African growth business and is not solely dependent on one geographic and regulatory environment.

I also think that the value on offer at Vodafone is a little more compelling.

However, BT’s dominant market share and its target of doubling free cash flow in five years are also quite tempting for me.

On balance, I think it’s probably too close to call as to which company would make the better investment today.

As always this article is only intended to provide ideas for further research, so please feel free to let me know what you think about BT and Vodafone in the comments below.