VODAF - Vodacom Group Limited (VODAF) Q2 2023 Earnings Call Transcript

Vodacom Group Limited (VODAF)

Q2 2023 Earnings Conference Call

November 14, 2022, 09:00 AM ET

Company Participants

JP Davids - Head of IR

Shameel Joosub - CEO

Raisibe Morathi - CFO

Conference Call Participants

Louise Pillay - Investec

Preshendran Odayar - Nedbank

Ntando Thukwana - Moneyweb

Presentation

JP Davids

Good morning, and welcome to Vodacom Group's Interim Results. My name is JP Davids, Head of Investor Relations at the Group. We're going to kick off in a moment with a couple of video presentations done by Shameel and Raisibe covering our strategy and results for the period, and then we will move into a live Q&A session and look forward to your participation then. Enjoy the videos.

Shameel Joosub

Welcome to our strategy and results highlights for the six months to September 2022. My presentation is structured into three sections. Firstly, and most importantly, I will give you an update on our purpose-led business model, which drives our strategy.

Secondly, I will provide an update on how we are accelerating our multiproduct strategy called the System of Advantage. Finally, I'm pleased to announce a good set of financial results as we continue to invest for long-term growth.

Vodacom is a purpose-led company. We connect for better future and are uniquely positioned to reach and empower millions of African consumers with our connectivity, digital, and financial solutions. We remain focused on our strong governance and our three pillars; digital society, inclusion for all, and planet.

Our inclusion for all pillar embraces a drive to provide access for all. This will be achieved by enabling connectivity, financing affordable smartphones, providing free access platforms and transforming pricing. Leveraging our big data and customer value management capabilities, we've accelerated contextualized and bite-sized offers to customers, improving access for all. These bite-sized offers help our customers navigate through the challenging economic conditions and the periods of sporadic income generation.

In South Africa, more than 60% of data bundles sold are now personalized. This outcome was enhanced by our commitment to lower prices to South Africa's poorest towns and provide free access by our connective platform.

These initiatives are being replicated across our international markets. I am particularly proud of our mobile healthcare program in Tanzania called m-mama. This service provides emergency transport for pregnant and postpartum women.

Tanzania has one of the highest maternal mortality rates in the world, many of which could be prevented by reducing delays in receiving care. It is estimated that the service has already helped reduce the maternal mortality rate by 30% in the Lake Zone region in Tanzania. Beyond Tanzania, we are working with the Vodafone Foundation and USAID to expand the m-mama to more markets in Africa, having already launched it in the DRC and Lesotho.

To improve food security, we are harnessing the power of digital technologies. We are leveraging the platform capabilities of mezzanine and M-Pesa to improve productivity, revenue, and resilience for farmers. One such solution is called Connected Farmer. It already has 1.5 million registered small-scale farmers in Africa connecting them to information, inputs, credit, and buyers to improve their outcomes.

Our IoT Solutions are also supporting energy-saving solutions creating cleaner and more efficient communities. We engage on these capabilities extensively at COP27. Beyond the IoT, Vodacom is pursuing numerous other climate projects, some of which include renewable energy-powered rural sites and pilot renewable energy solutions in South Africa with Eskom. These are just some of the initiatives we supported in the period, but there are many more, which we will provide more detail on in our sustainable reporting.

Vodacom is a clear and powerful strategy that sets us apart from the competition and is expected to deliver superior returns to you as the shareholders. We call our strategy the System of Advantage and it has 10 drivers of success. The first two drivers relate to our core connectivity offering. We are strengthening our footprint with a greenfield roll-out in Ethiopia and the Vodafone Egypt acquisition. We're extending our connectivity leadership, the smartphone adoption, rural access and scaling fiber. Whether customers want to connect via mobile, land or even space, we want to be the connectivity partner of choice.

With the Egypt acquisition, our population reach will exceed 500 million people across Africa, as connectivity remains a clear growth path for Vodacom. Our leading market share positions in connectivity provide us with the platform to scale our digital ecosystems. This ecosystem spans across big data, IoT, financial and digital services. Leveraging our big data capabilities, we can improve customer offerings and incentivize the next best activities.

Today, we know about 5,000 big data attributes about each customer. These insights support our world-class CVM and personalized pricing, but it also underpins our behavioral loyalty program and financial services products. By the way, compared with the 5,000 attributes we know about you, how many things do you know about yourself.

In the enterprise space, we are partnering with the business to accelerate that growth by transforming their operations through digital technology in high-growth areas like cloud hosting, managed security, managed services and IoT. These solutions are enabled and enhanced by our subsidiaries IoT.nxt, X-Link and Nexio, mezzanine and our associated AfriGIS.

In the financial services space, we have built a formidable business across our existing markets with products that categorize consumers and merchants. Vodacom success in this segment is a function of strategic focus. This focus has seen us continuously scale the breadth and value of our financial service products and offerings as we leverage world-class tech, such as Alipay.

As we pull our connectivity, digital and financial service capabilities together, we create a link around the customer. This is critical to our growth story. As we expand our addressable market, we are also making the customer proposition so much more than just a decision based on price.

As we implement our System of Advantage, we put in equal focus on considerations to improve our overall customer proposition, return on capital employed and value creation. A key part of this is optimizing returns and using the power of scale and sharing to drive down the cost to communicate. This is particularly relevant as we accelerate our deep rural and five aspirations.

Of all the elements in this slide, the most important is number 10. Our purpose-led model shapes our outlook and our business strategy. Our mezzanine platform is a good example of this in practice. It played a vital role in the vaccine rollout during COVID-19.

Mezzanine is now scaling smart agricultural solutions to subsystems and commercial farmers from the US to Australia and everything in between. Our smart agricultural solutions are a good example of our synergy and enabling our purpose and positively influencing our societal value.

We made major strides in accelerating our System of Advantage in the six-month period.

In support of Safaricom's long-term growth outlook, we're very pleased to have obtained a mobile license in Ethiopia. In October, we commercially launched operations in Ethiopia and attracted 740,000 customers by end of the month. Further, the government of Ethiopia announced that we will be awarded a mobile money license. This will help us accelerate our ambition to transform lives in Africa's second most populous country.

In Egypt, our acquisition of a controlling 55% stake now awaits approval from the Financial Regulatory Authority in Egypt. We expect Vodafone Egypt to contribute positively to our growth profile from the date of acquisition. To give you an idea of the scale of the group after the conclusion of the Vodafone Egypt deal, we will add their 44 million customers to reach almost 118 million customers in the group. In financial services, Vodafone Egypt already has 4 million customers, which will add to our base of 63 million.

Smartphone penetration will be just below 60% across the group, providing a long-term and structural growth opportunity for data. We will also have access to 40,000 network sites, and it will be one of Africa's largest of tower owners, if not the largest.

In September, we launched Tanzania's first 5G network, an important technology milestone for the country. Our 5G network will offer our customers a greater customer experience through faster speeds and lower latency. This will support the development of emerging technologies. In October, we acquired 110 megahertz of spectrum in Tanzania, almost doubling our spectrum portfolio in the market. Our financial services strategy is supported by a dual-sided ecosystem that provides a comprehensive product suite to consumers and merchants.

A notable highlight in the period was the acceleration of our merchant growth. With active merchants across international up fourfold to almost 137,000, while Safaricom's merchant base was up 39.3% to 539,000. This growth helps expand our revenue pool beyond peer-to-peer payments and withdrawals into both online and offline commerce. Consistent with our focus on optimizing returns but also connecting people, we have made good inroads on innovative new financing models for rural base stations.

In the fiber space, we are working on co-investment models to accelerate rollout across our international markets. I will have more on this later in the presentation. The first element of our strategy speaks sustained thing of our footprint. Safaricom has provided guidance for Ethiopia, including a long-term range 40% EBITDA margin target. In this slide we compare Ethiopia with Egypt to highlight the massive addressable market opportunities. For example, Ethiopia with a larger population size than Egypt generates US$1 billion of telecoms revenue. By comparison, Egypt is a US$5 billion revenue market with Vodafone Egypt, the clear market leader, generating US$2 billion of revenue at a 45% EBITDA margin.

Switching from connectivity to financial services. If we consider that almost 80 million people in each of Ethiopia and Egypt to unbank, the opportunity to drive financial inclusion is very exciting. Since M-Pesa's launch in Kenya, it has contributed to a 30 percentage point increase in financial inclusion. We intend to leverage the combined strength of M-Pesa Africa and Vodacom Financial Services to accelerate opportunities in these markets, including the rollout of our super-app.

Vodafone Egypt is delivering excellent financial results with service revenue growth of 18.6% and EBITDA up 21.4% in the six-month period. Further, the scale of Vodafone Egypt means that it will diversify the composition of the group's operating profit. Based on the results for this period, South Africa's contribution would reduce from 73.1% down to around about 55%.

Looking ahead, Vodafone Egypt's growth is supported by leadership across both the consumer and enterprise segments. It has a clear network and spectrum advantage versus peers and a brand synonymous with technology leadership. Building on this connectivity scale, Vodafone Egypt also offers a very exciting FinTech opportunity. We look forward to closing the transaction in the near term.

Aligned with our ambition of digital inclusion, we are working to reach more under-serviced rural areas across all markets. To extend our rural reach, we have developed a ring-fenced SPV model for base station deployment. We have commenced with a proof-of-concept in the DRC with 100 new rural sites. The learnings from this PoC will help shape the rollout of infrastructure in deep rural areas across markets.

To drive both rural and next-generation mobile access, spectrum is key. In addition to the 110 megahertz of spectrum we secured in South Africa, we've recently acquired another 110 megahertz of low and mid-band spectrum in Tanzania. The investment will help unlock a very exciting growth path for fixed wireless access on the continent.

To complement our mobile leadership, we are committed to establishing more scale in fixed services across the continent. Last year, we announced a major step forward in the scaling of our fiber footprint in South Africa through the acquisition of and up to 40% stake in CIVH's fiber assets.

In addition to accelerating fiber reach in South Africa, the transaction provides a blueprint for shared-cost fiber rollouts across our markets. Providing customers with access to smartphones remains a high priority. Affordability of these devices is, however, a challenge, especially with foreign exchange volatility and supply chain challenges. In Kenya and South Africa, we have developed innovative models for prepaid handset financing, which we intend to scale across our markets.

We have built a formidable financial service business. To capture more of the addressable FinTech market, we are building a dual-sided ecosystem that aims to deliver exceptional and personalized experiences relating to entertainment, lifestyle, e-commerce, payments, savings, investments, lending, and insurance services.

Our super-apps are a key driver of this strategy as they create an open platform where we can integrate our own products with thousands of external service providers. It removes the barrier of physical limitations for both consumers and merchants, which then gives them the opportunity to expand their offerings well beyond their geographical boundaries. And, put simply, as the transactions compound, we take our cut, a bit like in iOS or Google Play Store.

To complement our super-apps, we are also scaling our merchant acquiring products. We have launched our own Android-powered physical point-of-sale devices in South Africa, adding to the already scaled [indiscernible] service. This payment ecosystem provides insurance and lending opportunities, such as invoice financing and SME lending.

Further, our enterprise resourcing planning to go voucher trade, facilitates transactions between merchants and FMCG operators. Across our M-Pesa footprint, we are seeing strong traction across both our consumer and merchant propositions.

At the heart of this is the M-Pesa app, which is already scaled in payments and we are building out more capabilities. Across our M-Pesa footprint, including Safaricom, 30-day active app users now exceeds 3.2 million. In just six months, we have granted loans by M-Pesa of US$2.8 billion and facilitated US$2.1 billion of international money transfers.

On the merchant side, we now have a base of 676,000, up 63% with Tanzania passing 100,000 merchants in the quarter. This merchant scale helps us diversify our business and opens up significant addressable markets in day-to-day commerce.

For example, in Tanzania alone, our merchant solution called Lipa Kwa Simu processed payments of US$1.1 billion in the six-month period. In South Africa, our lifestyle super-app VodaPay is supported by the world-class technology of Alipay. It offers services ranging from loans, seamless QR codes, and person-to-person payments to entertainment personalized shopping experiences with many more services such as savings and investments on the product roadmap.

Launched almost a year ago, our super-app VodaPay reached 2.2 million registered users and 3.5 million downloads by the end of September. We expect good user adoption for the super-app in the coming quarter as we have made it central to our summer campaign and we will add critical new functionality, including cash-in and cash-out capabilities, soon. We already have over 100 mini apps on VodaPay offering customers a wide variety of products and services. These mini-apps act like a virtual mall with the tenants able to acquire customers significantly cheaper than a go-it-alone strategy.

Airtime Advance revenue accelerated to 7.5% in the second quarter, supported by customer growth. We advanced an impressive ZAR 6.3 billion of Airtime in the period. Leveraging our dual-sided financial services strategy in South Africa, we have introduced new products with encouraging progress in areas such as merchant acquiring. We have processed ZAR 2 billion in merchant payments in the period and executed on ZAR 4 billion in supply chain financing. Our insurance portfolio had excellent growth with policies up 19.4% to 2.6 million. Leveraging on the success of VodaSure in South Africa, we intend to scale our insurance products across our footprint.

Turning to the group's financial results. Despite ongoing financial market volatility and weaker prospects for the global economy, Vodacom delivered strong revenue growth, evidenced by 7.7% increase in group revenue to ZAR 53.7 billion in the period. Service revenue grew at 7.2% to ZAR 41.7 billion, supported by a resilient performance in South Africa and the accelerating growth in international. Group service revenue growth was underpinned by data revenue growth in new services, which includes digital and financial services, fixed and IoT.

We invested ZAR 7.6 billion into capital expenditure, excluding the costs of acquiring spectrum. Capital expenditure increased 9.8% as we accelerated investment into network performance. Pleasingly, our continued investment in South Africa is extended our network NPS leadership score.

Group EBITDA increased 0.6% to ZAR 20.2 billion and was subdued by an acceleration of network operating expenditure in South Africa, higher energy costs across the group and a lease contract separation in the DRC. We do expect a clear improvement in EBITDA growth into the second half of the financial year as we accelerate cost initiatives and lapped the impact of accelerated network operational expenditure in South Africa, the lease contract separation and levies on mobile money transactions in Tanzania.

Our efforts to deepen financial inclusion continue to thrive, supported by the double-digit increase in financial services customers to 63 million. It was particularly pleasing to report a strong recovery in Tanzania's M-Pesa customers supported by lower mobile money levies and strong traction for new financial services.

Headline earnings per share declined 9.5% to ZAR 4.57 per share. The decline was largely attributable to start-up losses in Ethiopia and higher finance costs. Raisibe will unpack this more in her presentation.

Separately, the Board declared an interim dividend of ZAR 3.40 per share, which reflects our updated and simplified dividend policy. Pleasingly, we delivered growth across each of our segments. Group service revenue was up 7.2% on a reported basis, while normalized service revenue was up 3.9%. South Africa grew at 3%.

Our international operations reported service revenue growth of 17.9% and normalized service revenue growth of 5.6%. Safaricom service revenue grew 4.6% in the period.

Group operating profit decreased 5.6% with ZAR 13.1 billion as EBITDA growth was offset by higher depreciation and amortization. Higher depreciation was as a result of a deliberate step up in CapEx intensity over recent periods to improve network resilience in South Africa and expand 4G coverage across our international markets. This investment supported our revenue resilience in the period. Further, Safaricom's contribution declined 7.3%, reflecting the expected start-up losses in Ethiopia.

On a normalized basis, group operating profit decreased 5.1%. And excluding the impact of the start-up losses in Ethiopia, Safaricom's contribution to operating profit grew 4.9%. When looking at our customers, 67% of our 133 million customers are outside South Africa. The split will increase further as we add Egypt's 44 million customers into the portfolio.

Shifting to our product lens. This slide sets out the contribution of our high growth new services to each of our geographic segments. Our new services comprise IoT, fixed, financial and digital services. These services follow a similar product lifecycle. This starts with innovation, which is driven by dedicated innovation hubs and its data driven. Services are then integrated into our System of Advantage and scale to support our growth ambitions.

Our optimization phase for these assets could take different forms in the future and could include structural separation and potentially partial monetization to better reflect the underlying value of these assets. In South Africa, 14.5% of service revenue is now attributable to new services. We intend to scale each of these new revenue streams into formidable businesses.

Across our international portfolio, the contribution of new services is closer to 29%, whilst Safaricom sets the benchmark at 44.2%.

This slide sets out matrix that highlight the scale of our financial service business. We are now processing US$355 billion of transactions through our platforms. This is up 17.6%. In the period, our revenue on a consolidated basis was up 10.7% to ZAR 4.4 billion. This included revenue in South Africa of ZAR 1.4 billion, up 8.1%.

Growth in South Africa was underpinned by our insurance business with policies up 19.4% to 2.6 million and an acceleration of Airtime Advance revenue growth. Our international business delivered M-Pesa revenue of ZAR 3 billion in the period, up 25.2%. As we show on the right-hand side of the slide, half of this growth was fueled by new services such as business payments, international money transfers, loans and saving products. These new growth drivers now make up more than a quarter of internationals M-Pesa revenue, confirming that our dual-sided ecosystem is scaling.

Safaricom, which sets the benchmark for product scale, generated M-Pesa revenue equivalent to ZAR 7.9 billion in the period. The growth of 8.7% was subdued by the August election cycle. Encouragingly, the underlying growth drivers, including the super-app evolution, continues to make excellent progress.

In South Africa, service revenue grew 3% to ZAR 29.5 billion, supported by the mobile contract segment, a resilient performance in prepaid and then growth in our new services. New services were up 7.6% and contributed ZAR 4.3 billion of service revenue. In the second quarter, service revenue growth accelerated modestly to 3.1%. This was supported by the excellent traction of our personalized bundles, which offer lower rates and bite-sized options to the most price-sensitive lower-income consumers.

Our prepaid data revenue growth accelerated to 11.8% in the second quarter, despite the economic headwinds. Vodacom business made up almost 30% of service revenue in the period, growth of 2.1% was dampened by the RT15 government contract and wholesale revenue as we lapped a strong prior-year period. Encouragingly, Vodacom Business Mobile contract revenue was up 7.2%, supported by 6.2% increase in business customers. Data traffic for South Africa was up 30.3% in the period.

We added 800,000 data customers, reaching 23.8 million customers, up 4.1%. Smart devices were up by 11.8% to 27.6 million, while 4G and 5G devices increased by 24.1% to 20.3 million. The average usage per smart device increased by 24% to 2.8 gigs per customer per month.

EBITDA declined by 0.6% to ZAR 15.8 billion as we accelerated network operating expenditure and reverted to pre-COVID levels of back-to-office expenses such as publicity, office accommodation and travel.

The network resilience program was initiated in the second half of the previous financial year to address power challenges and higher rates of theft and vandalism. Importantly, this focus on network OpEx along with our sustained CapEx investment extended our network NPS leadership.

Further, on the expense side, consumer price inflation accelerated to 7.1% in the period, above normal trends. As Raisibe will discuss in her presentation, we intend to accelerate cost initiatives into the second half to address these inflationary pressures and accelerate EBITDA growth.

Our international operations reported service revenue growth of 17.9% to ZAR 12.6 billion, supported by strong growth in data, recovery in M-Pesa and foreign exchange translation tailwinds. Normalized service revenue growth was 5.6% in the period and accelerated to 8.7% in the second quarter. M-Pesa was the key contributor of the second quarter acceleration, supported by excellent growth in new financial services and a further reduction of mobile money levies in Tanzania from July 2022.

Data revenue growth remained strong throughout the period, increasing 32% to ZAR 2.8 billion. Data traffic was up 34.7% with an encouraging uptick in smartphone penetration of 1.8 percentage points. The potential for increased smartphone adoption and data usage remains high and will be accelerated by the innovative prepaid handset financing solutions I mentioned earlier.

Our customer base increased the 3.3% to 43.9 million with net additions of 1.2 million in the second quarter, supported by our price transformation in Mozambique. Customer growth for our international operations is critical for us to achieve our 2025 ambition of improving the lives of the next 100 million customers.

M-Pesa revenue of ZAR 3 billion contributed 23.8% of service revenue. In the second quarter, growth accelerated meaningfully to 39.3%. This acceleration was driven by Tanzania, which lapped the impact of levies on mobile money that was introduced last year. On a reported basis, EBITDA grew 9.5% to ZAR 4.8 billion. However, international EBITDA margin contracted by 2.7 percentage points. The EBITDA performance was impacted by the accounting for lease contract separation in the DRC.

Looking ahead, we expect an improved EBITDA performance in the second half of the current financial year as we lapped the DRC lease impact and the levies on mobile money in Tanzania. Safaricom delivered a good set of results given the challenging macro backdrop, reduction in mobile termination rates and investment into Ethiopia.

Service revenue of 4.6% was supported by recovery in mobile data growth and an excellent performance in the fixed business. M-Pesa revenue grew 8.7%, subdued by the August election cycle. Encouragingly, platform growth was excellent with total M-Pesa transaction values up 32% to KES18.1 trillion. M-Pesa revenue now contributes close to 40% of Safaricom's service revenue.

Fixed service revenue grew 23% to KES6.8 billion, supported by 26.8% growth in Fiber-to-the-Business revenue and 16.2% growth in Fiber-to-the-Home revenue. Fiber-to-the-Business customers grew 16.6% or Fiber-to-the-Home customers were up 13%. Mobile data revenue grew 11.3%, accelerating from the prior year growth rate as price transformation supported excellent usage growth.

EBITDA for the Kenyan operations was up 3.1% with margins broadly flat at 52.2%. Safaricom's overall EBITDA, including Ethiopia, declined 4.3%, reflecting the start-up losses associated with the Ethiopian roll-out. As mentioned earlier, Ethiopia represents a transformational opportunity for Safaricom.

Raisibe Morathi

In this video, I will unpack our results for the six-month period ended September 30, 2022. We have delivered excellent revenue growth in this period, despite mounting macroeconomic challenges. We're also sharpening our focus on costs, but more on this in my presentation.

From a shareholder perspective, we have declared an interim year dividend of ZAR 3.40 per share and this dividend reflects our new policy, which positions Vodacom to accelerate growth going forward.

Moving to our financial performance, our income statements sets out reported and normalized growth. I will primarily draw attention to the normalized growth numbers, which provide better insights adjusted for ForEx fluctuations as well as M&A activity.

Our revenue increased by 7.7% or 5% on a normalized basis supported by service revenue growth, which was up 7.2% on a reported basis and 3.9% on a normalized basis. EBITDA declined 1.8% on a normalized basis at a margin of 37.6% and this was impacted by some one-off factors and phasing of OpEx, which I will unpack later. The net profit from associates and joint ventures of ZAR 1.5 billion was impacted by finance costs and startup losses associated with our rollout of Ethiopia.

On a normalized basis and excluding the impact of Ethiopia, Safaricom's contribution to our operating profit increased 4.9%, reflecting a resilient underlying performance from the Kenyan operations. Headline earnings per share decreased 9.5% to ZAR 4.57 and was impacted by higher finance costs and the expected start-up losses for Ethiopia. Our underlying operational earnings performance was broadly stable year-on-year.

As set out on the previous slide, normalized service revenue growth for the group was 3.9% in the six-month period. Notably, group normalized growth improved from 2.9% in the first quarter to 4.9% in the second quarter of this financial year. While South Africa delivered a fairly consistent level of growth quarter-on-quarter, our international business delivered a tiered improvement in the second quarter.

Normalized growth accelerated from 2.4% in the first quarter to 8.7% in the second quarter. M-Pesa was the key contributor of the second quarter acceleration, supported by excellent growth in new financial services and a further reduction of mobile money levies in Tanzania from July 2022. At a group level, our EBITDA growth tracked below our medium-term target.

In this slide and the next one, I will provide some more color on our expense and EBITDA trends, and why we see improved prospects into the second half of the financial year, starting with operating expenses in South Africa. This were 9.7% in the - in this period. There were a few factors that impacted expense growth in the period and this are set out in the waterfall chart.

Foreign exchange related to our day-to-day trading added 1.1 percentage points, while our accelerated network spend and higher energy costs added 3.7 percentage points. The network costs were as a result of our resilience program that was initiated in the second half of the previous financial year to address power challenges and higher rates of theft and vandalism. Pleasingly, this intervention extended our market-leading network NPS position in the period.

Back to the waterfall, the back-to-office expenses such as office, travel and publicity contributed 2.1 percentage points. Then, of course, there was an impact of inflation, which affects areas like payroll costs as we increased salaries by 5% at the start of the financial year. While not presented in this slide, direct costs were up 7.8% in the period. A key driver of this growth was higher handset cost of sales. This was offset by strong growth in equipment revenue, but does weigh on EBITDA margin.

The second half outlook for South Africa's expenses is better. We will lap the impacts of the accelerated network and back-to-office costs. Additionally, and mindful of inflationary pressures, we have already implemented new cost initiatives in supply chain management and payroll and in any indiscretionary areas like travel and events.

In this slide, we provide more context around our group EBITDA growth drivers. The chart on the left-hand side provides a year-on-year bridge for EBITDA. Overall, growth was a modest 0.6% and, however, as you can see, it was negatively impacted by a few factors that we do not expect to impact in the second half. This includes one of lease contract separation in the DRC and certain expenses in South Africa, such as network OpEx acceleration. The lease separation in the DRC increased operating expenses, but was offset by a reduced right-of-use depreciation and interest and so there was no impact on net income.

As we look into the second half of the year, it is also important to note some of the growth headwinds at play in the prior period. Notably, the impact of the lease contract in DRC was very material in the second half of last year. This is highlighted on the slide on the right-hand side and, also, we will lap the impact of Tanzanian levies, the back-to-office and higher network costs in South Africa.

This, combined with our incremental cost initiatives, provides a scope for an improved EBITDA performance in the second half. While we reported group EBITDA of 0.6%, our net profit was down 9% and this slide sets out the key drivers of the decline. From EBITDA, higher depreciation and amortization, startup costs related to Ethiopia and restructuring costs more than offset the underlying growth in associates.

The higher depreciation and amortization is as a result of capital expenditure growth over the recent years and the translation impact of a weaker rand. Below the operating profit line, higher finance costs were offset by lower taxation with the result that net profit declined 9%. The change in finance costs were as a result of the higher net debt and interest costs and adverse foreign exchange movements. I will unpack the net debt movements in the upcoming slides.

Taxation was lower in part due to the recognition of deferred tax asset in Tanzania. The recognition of this asset reflects improved medium-term profitability prospects for our GSM business in Tanzania. Into the second half, EBITDA growth is a key lever to addressing the shape of net profit outcome for the financial year.

Still forecast on the bottom line, our HEPS decreased 9.5% to ZAR 4.57 per share and, as already mentioned, earnings were impacted by a few notable factors. In this chart, we show the after-tax, after non-controlling shareholder impact of the sectors on earnings per share. The most significant of this related to the start-up losses in Ethiopia and the higher finance costs.

The Ethiopia losses weighted on the contribution from Safaricom in the period and impacted our HEPS by ZAR 0.20 per share. After-tax, higher group finance costs had a ZAR 0.23 per share impact. Other notable earnings factors included M&A and restructuring costs, which offset - which was offset by the recognition of deferred tax asset in Tanzania.

Accounting for all these notable factors, our underlying operational earnings base was broadly flat year-on-year. We are not satisfied with delivering flat operational growth and, therefore, we target an improvement going forward.

Shifting focus to cash flow and operating free cash flow. This was ZAR 4.8 billion down, i.e., 25.6% year-on-year. While this is a material change, it is in line with our budgeting and free cash flow phasing for the year. In the first half, we posted a seasonal working capital outflow of ZAR 5.7 billion. This was higher than last year as we paid CapEx creditors from the prior year and invested more into inventory. Both these factors were taken to mitigate supply chain challenges and foreign exchange volatility. Additionally, CapEx of ZAR 7.6 billion was also up 9.8%.

Lease liability payments, which is also captured in operating free cash flow, amounted to ZAR 2.4 billion. From operating free cash flow, we received dividend from Safaricom and paid cash taxes and finance costs. On this basis, we generated free cash flow of ZAR 2 billion. As I mentioned, while free cash flow was down year-on-year, this was in line with our own expectations. The timing of tax payments and the CapEx creditors were material factors.

Our cash tax payment of ZAR 3.6 billion was higher year-on-year, despite a 15% lower profit and loss charge. This reflects the timing of provisional and final tax payments and should correct in due course. The capital creditor of ZAR 1 billion relates to the cash payment for higher CapEx incurred in the final quarter of the prior year. We had accelerated this CapEx to capture a stronger rand and just as well given the rands volatility.

In the current period, CapEx was higher year-on-year as were our finance costs. While free cash flow generation in this period was modest, this is very much in line with our multi-year pattern. The chart on the right shows our free cash flow generation, which is skewed in the second half. We expect the same trend to play in this year.

We communicated a change in dividend policy with our Vodafone Egypt and CIVH transactions announced in November 2021. Given the regulatory progress on the Vodafone Egypt acquisition, the Board has implemented the policy from this period. A simplified policy is to pay out at least 75% of the group headline earnings per share, which remains one of the highest payout ratios on the JSE.

For this period, the Board has declared an interim dividend of ZAR 3.40 per share, and this is based on a payout ratio of 80%, slightly above the minimum threshold. This recognizes that our acquisition of Vodafone Egypt has not yet completed. Our net debt to EBITDA ratio increased from 0.9 times to 1.1 times in this period. We provide the key drivers of this change in the waterfall chart.

As discussed already, free cash flow of ZAR 2 billion was seasonally low. Additionally, we paid ZAR 3.2 billion for spectrum in South Africa. Looking ahead to the second half, we expect significantly stronger free cash flow generation and lower dividend payment to improve the leverage outlook. We do, however, anticipate some further lumpy payouts, including the balance of the spectrum costs in South Africa, which is ZAR 2.2 billion and a separate ZAR 600 million cash payment for the recently acquired Tanzanian spectrum.

And then from an M&A perspective, we are working to close the Vodafone Egypt transaction as soon as possible. The Vodafone Egypt transaction is not expected to meaningfully change our leverage ratio, given the acquisition is 80% equity funded and Vodafone Egypt itself has limited gearing.

Looking at the composition of our borrowings, our near-term facilities increased due to upcoming maturities of debt with Vodafone Luxembourg. We do not foresee any refinancing risks related to these borrowings, some of which is already in progress. More than 90% of our debt, excluding leases, is rand base, limiting our exposure to foreign exchange movements.

From an interest rate perspective, our debt structure is split 56% fixed and 44% floating rates. If we exclude leases and forecast on financial debt, the fixed component is 40%, while floating rate debt is 60%. This mix suggests in the current interest rate cycle, our average cost of debt will increase but not by the full extent of the interest rate hikes. We intend to optimize this mix of debt as we undertake future funding obligations, such as the Vodafone Egypt and CIVH transactions.

And now to our medium-term targets. We aim to grow service revenue in mid-single digit and EBITDA at mid to high single digits. Our group capital intensity ratio remains in a range of 13% to 14.5% of revenue. Notably, this guidance excludes Egypt and it is based on the prevailing economic climate. Clearly, the Russia-Ukraine poses a material risk to the outlook for inflation and growth across our markets. While we are optimistic that our strategy and business model are resilient, we are also realistic that the cost of living is a challenge that we will need to overcome with our customers.

Finally, we expect the Vodafone Egypt and CIVH fiber asset acquisitions will enhance our System of Advantage and provide scope for diversity and accelerate our group growth profile.

In my concluding slide, I would like to reconcile our medium-term growth target with a shape of our business in the years to come and, in particular, our ambitions around new services. These new services encompass digital and financial services, fixed and IoT, and are key to us diversifying our revenue portfolio and improving our customer proposition. On a consolidated basis, with South Africa and international business in scope, we see our new service revenue contribution increasing from 18.9% to around 25% to 30% in the medium term.

On that exciting note, I will conclude, and thank you for your attention.

Shameel Joosub

To conclude our presentation, I would like to set out how we plan to create value for our shareholders. Firstly, we will continue to execute on our multiproduct approach, our System of Advantage, by completing our M&A transactions announced last year.

We are hopeful that the Egypt transaction will be completed soon, subject to the final regulatory approvals. The CIVH deal will accelerate fiber reach in South Africa, fostering economic development. The regulatory approval process is proceeding with us having received the regulated ICASA approval. This is a big step with only the competition authorities' approval outstanding.

Opportunity for growth in FinTech in South Africa and M-Pesa is significant and remains a key priority for us. And we are very excited about the scaling of our super-apps, considering the exceptional growth we have witnessed so far this financial year.

Transforming to a TechCo will include optimization of our assets and, to this end, we aim to unlock benefits from separating out our towers in South Africa this year. We will continue to adopt a disciplined capital structure and allocation of capital resources. We have simplified and updated our dividend policy, still offering one of the highest pay-outs on the JSE.

In terms of capital expenditure, we will invest within the framework of our capital intensity guidance. Accelerating and diversifying returns to our investors remains a key priority and we will continue to accelerate the group's growth potential with earnings and free cash flow, whilst at the same time improving our return on capital employed.

Finally, we will always prioritize our contribution to the societies in which we operate, now our purpose-led ambitions. We are focused on increasing our female representation at management level, reducing our greenhouse gas emissions across the footprint, and driving financial inclusion. These targets are included in management's long-term incentives.

We look forward to engaging with you over the coming weeks in our investor roadshows. This concludes my presentation. Thank you for your attention.

[Video Presentation]

Question-and-Answer Session

A - JP Davids

Okay. Good morning, again, everyone. And so we're going to kick off a Q&A session in a second. May I ask that if you do have questions, you try and limit them to two rather than five. We don't have - well, I don't have a little scratchpad. But perhaps before we get to the Q&A, I'll just hand over to Shameel for a quick update on the Egypt transaction.

Shameel Joosub

Thank you, JP. Yesterday, in some big news, we got the FRA approval in Egypt. So it was granted yesterday and that now leaves us with a few procedural processes for the deal to be fully complete, a very big step for us. Indeed.

JP Davids

Okay. If anyone has questions in the audience, please raise your hands. Here we go. Louise in front.

Louise Pillay

Hello. It's Louise from Investec. I'll be kind this time and ask one question. And I think on your cost saving initiatives, you said you are going to be sharpening your focus in the next half. And can you be more direct and give us specific cost saving initiatives? And which areas of the businesses that you are targeting? And, I think, generally the third quarter is quite a good quarter for handset sales, so we do expect some margin compression to come through in the third quarter, but if you can just give us more color to understand how the shape would work? Thanks.

Raisibe Morathi

Thanks, Louise. So we actually started noting the higher inflationary impacts, so we're looking at energy costs and negotiating with the oil majors in terms of the diesel side of things and negotiating with the oil majors to get wholesale pricing.

So that applies currently in SA. But we're looking at expanding that reach to the other markets. The discretionary costs just limiting some of the activities to do with travel, to do with the functions and just basically scaling them and leaving them to on a need basis. And we are looking at the suppliers across the board renegotiating some of the contracts where possible and applicable and where we can limit the FX-based implications in terms of the cost, so that our costs are basically in local currency denominations.

So it's the scale of activities and this is something that is not new. For us, it's really just a continuation of the work that has been done in the past. But, obviously, in recognition of the current environment, it's really just to continue to sharpen the pencil.

Shameel Joosub

In addition, this is in the lapping of the costs, because we had a lot of the pre-COVID costs that came back last year and in the second half we lapped those costs as well as the DRC lease adjustment.

JP Davids

Preshendran?

Preshendran Odayar

Thanks. Hello. Hi. It's Preshendran from Nedbank. Firstly, Shameel, congrats on getting that deal. Most people come back from Egypt with chocolates, you came with a much better present for the rest of shareholders. So well done on that.

Shameel Joosub

Thank you.

Preshendran Odayar

I'll ask my two questions. I thought if I use the VodaPay app, I'll get one more free, but we'll trial later. Firstly, some guidance on balance sheet in the second half, Raisibe. Obviously, you have to pay the dividend and there is a second spectrum payment. What's your target gearing for 2H? And then the second question, your thoughts, for both Shameel and Raisibe, on Cell C post its recap? How do you see this play in the market affecting your business, particularly any impact you might see on Capitec and the MVNO on your network base? Thanks.

Raisibe Morathi

So starting with the net debt to EBITDA, so in the second half, whilst we would have paid the ZAR 2 billion of the spectrum, but that is also the period when we expect our EBITDA to grow better than the first half and for that reason we expect that our net debt to EBITDA should not be materially higher than the 1.1 times.

And we do make a point that should we have the Egypt transaction consolidated in that period, obviously, it will increase the debt that comes with the 20% that we settled in cash, but the consolidated component is actually positive contributor to the overall percentage. The net debt to EBITDA in Egypt is a way below the levels at which we are operating, it's below 1 times. So, for that reason, we guide that, at peak, we still expect our net debt to EBITDA to still be below 1.5 times.

Shameel Joosub

Yes. I think on Cell C, I think the recap is very encouraging, in that, of course, it's a very big customer for us with their contract roaming revenue going through us. So I think having get - having gotten that financial stability or improved financial stability, I think, it's a good thing for the market.

In terms of Capitec, we're monitoring the progress. The way we see it, our offers are, if we're looking at our effective rate, say, still, we're well below the rates that Capitec is seeking to charge. But we will closely monitor any developments in that space.

Preshendran Odayar

Thanks.

JP Davids

Any other questions in the room before I switch to the online questions. Yes. Okay. There we go. One more.

Ntando Thukwana

Good morning. It's Ntando from the Moneyweb. We currently, in South Africa, operating in an environment that is increasingly facing load-shedding and I just wanted to know if you've seen any material reductions in data usage because of it? And what's - what is the group doing to sort of combat and mitigate against the effect of load-shedding?

Shameel Joosub

Yes. So we've done a number of things that, I think, we have the advantage of our competitors in this respect. We've invested quite heavily in terms of creating network resiliency and we've spent over ZAR 2 billion in the last two years. Some of the consequences you're seeing in the financials, to be frank. But from a network perspective, we've seen our network resilience be much better than competition. That's coming through in our NPS scores. So the investment has definitely paid off.

In terms of traffic, we've added 30% increase in traffic. So very good increase in traffic as well. What we do see during, let's say, the load-shedding is, we've actually seen an increase in data utilization for as long as the sites stays up, because if it's rolling blackouts, what happens then is that you only have that additional data revenue for as long as the sites up and then of course eventually when the batteries will die. And that's where you kind of lose. But we've tried to make sure that what the batteries rollout that we put in that we've created a lot of resilience. It's not perfect, but of course it's much better than competition.

JP Davids

Okay. I'm going to shift gear to some of the online questions. The first one I'll take, because it's the simplest we've had so far, so I feel comfortable with that one. From Nadim at SBG Securities. He is asking the impact of M-Pesa levies cited of around ZAR 200 million. How much did this impact the second quarter compared to the first quarter?

The answer there nice and simple. That impact is all related to the first quarter of the financial year. There was no material impact in the second quarter of the year as we have started lapping the levies. And then as was called out in the video, there have been further reductions in the levies from the 1st of October and that is positioning M-Pesa for significantly better second half of the year than first half of the year.

Then we got a few questions from Madhi Singh. I'm just going to - from HSBC. He was asking for an update on the Egypt transaction, which I think we've given, but he has a specific question as to whether there will have to be a bid for minority shareholders, but specifically Telecom Egypt, their 45% stake as a result of this transaction? And then I will go to his next question once that's dealt with.

Shameel Joosub

Yes. I think there will be a mandatory offer for the 0.015 shareholder, but they will be - and there is a waiver in terms of the Telecom Egypt. So there is no mandatory offer for Telecom Egypt.

JP Davids

And then coming back to cost inflation. Madhi had another question just around, I guess, higher diesel cost, but perhaps better just to frame it around energy costs, how those have impacted in the first half of the year and maybe, perhaps, I guess, a bit of reference for where we can land for the full year in terms of energy inflation across the group?

Raisibe Morathi

So, overall, we expect the increase to be roughly in the ballpark of about ZAR 0.5 billion. We are putting a lot of initiatives, obviously, that doesn't run rate into years to come. So, as an example, we announced a few months ago that we will be putting solar panels across this whole campus and we'll also look at other areas where we can be able to use the alternative energy. We're looking at getting into more impactful IPP arrangements, so that can alleviate those costs. And, again, it is pretty much in line with our - the ESG strategy to migrate in that direction.

JP Davids

Okay. And those are the questions I had online. And it seems like we're done in the room also. So, with that, we will close out with a very exciting - pardon me, there is one more question at the top there and then we will close out.

Unidentified Analyst

Hi, everyone. Thanks for the opportunity to ask questions. My name is [Sandro] from HSBC. So my question is, with load-shedding happening, what sort of trends do you see on the super-app happening? Do you see users using - that the vendors on the - that are enrolled in the app like the offerings of food and stuff like that? What sort of trends do you see like users taking part in the super-app? Thanks.

Shameel Joosub

Honestly, no real linkage besides the buying of electricity through the super-app, but I wouldn't say any linkages directly to load-shedding. We more see the load-shedding part coming through in the - on the network side very effectively. When the power is out, people go to their phones and there you do see an increase in utilization.

JP Davids

Okay. One last look around the room for hands. Okay. In that case, we will now close out with a very exciting video from the launch of our Ethiopian operations. It's just 2.5 minutes long. So I'd encourage you to enjoy it. Thank you.

[Video Presentation]

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Vodacom Group Limited (VODAF) Q2 2023 Earnings Call Transcript