We wrote about VEON Ltd. (VEON) last October and stated that we did not see much downside risk in shares at the time. The valuation was a principal reason for our bullish stance but another strong reason was the strong buying volume trend which demonstrated strong accumulation of shares. When we penned that article, shares were trading around the $2.40 level. Shares now are trading at approximately $1.45 per share meaning they have lost close to 40% over the past 7+ months. Suffice it to say, we were lucky we did not pull the trigger on this stock as we got this call at least in the short term completely wrong.
The question now is whether the sizable drop shares have undergone since mid-February is totally related to the coronavirus pandemic or is the “story” behind this company fundamentally flawed. For a start, shares of the telecommunication company are now trading for just over 10 times earnings and 0.9 times cash flow. Looking at these numbers straight off the bat, it would appear that the firm has plenty of liquidity to come through this latest downturn although we will have to delve more into these numbers.
Before we dig more into the valuation, however, let’s research VEON’s profitability metrics. EBIT came in at $2.235 billion in 2019. When we take into account the recently announced $407 million EBIT Q1 number in 2020, the trailing twelve-month number has slipped to $1.847 million. This is not bad in itself considering the one-off gain of $350 million related to Ericsson (NASDAQ:ERIC) in the first quarter of 2019.
This means in order to calculate a trailing average, a generous net income of $530 million in the first quarter of last year must be removed from the calculation. Having reported $108 million in the first quarter of this year, the trailing bottom-line number now comes in at $235 million. This drop in net profit has obviously affected the ROE or return on equity percentage to 10.5%. The return on assets percentage also has taken a sizeable drop to come in at 1.5% over the past four quarters. Despite the drop in profitability, however, VEON is still more profitable than the averages in this sector by a considerable distance.
In the second quarter of this year, the firm is still expected to make a profit ($0.03 per share) although the Russian market continues to see headwinds. VEON’s biggest market saw a contraction in revenue of 2.6% in the first quarter and a loss of 1.4% of its mobile customers due to elevated competition. Although the fixed-line market increased its revenues by almost 9% in the first quarter, the 4.2% decline in the much bigger mobile segment resulted in a significant contraction of revenue in this key market.
Management has been conducting a juggling act in Russia by shutting stores at the same time as building out its infrastructure. It really needs its growth engine markets (Pakistan, Uzbekistan, Kazakhstan, and Ukraine) to now stand up and deliver. Excluding forex headwinds, the likes of Kazakhstan and Ukraine saw significant double-digit top-line gains in their local currencies. If Pakistan and Uzbekistan can now take the lead, it would take the pressure off the adverse situation in Russia which is by far the firm’s biggest market.
When we go to the cash flow statement, we can see that trailing operating cash flow of $2.745 was able to pay for capex, the dividend, and other financing activities. The $88 million net borrowings in this period were more than covered by the almost $200 million increase in cash. Therefore, considering the healthy cash flow and valuation of VEON at present, value investors will be looking at this stock especially for its 20%+ dividend.
The projected revenue growth over the next few years should protect the payout although interest expense at present comes in at more than 50% EBIT, so this trend is worth watching. We are dealing with fine margins here which is why earnings reports should be watched closely to ensure cash flow remains buoyant.
Therefore, to sum up, the second and third quarters are going to be vital for VEON. We believe if earnings and sales can slightly increase in 2020, it would help the “value case” a lot going forward. Remember, this company is still profitable and is easily covering the dividend. Suffice it to say, we may initiate a small position here once we see further proof that the lows are in.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VEON over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.