2023-07-17 13:21:18 ET
Summary
- Telecommunication stocks are experiencing a downturn, with AT&T down nearly 25% YTD and Verizon down about 15%; T-Mobile, however, has remained stable.
- Vodafone Group Public Limited Company, a dividend-paying telecom stock, is down about 8% YTD and nearly 60% over the last five years, despite a current yield of over 10%.
- Although Vodafone's earning per share has been under pressure for a while, Free Cash Flow, Debt, and Cash levels offer some comfort.
- While dividend appears safe for now, I believe there are better places to invest.
It is fair to say that telecommunication stocks are down in the dumps and articles like this one are coming up thick and fast on Seeking Alpha arguing that these stocks now present a significant buying opportunity. For example, AT&T, Inc. ( T ) is down nearly 25% YTD while Verizon Communications Inc. ( VZ ) is down about 15%. T-Mobile Us Inc ( TMUS ), which I recently profiled, has bucked the trend and is flat for the year.
It is somewhat odd that the stocks that pay hefty dividends (AT&T and Verizon) are down significantly but the one that does not pay dividend (T-Mobile) has held up much better. I understand "risk on" trades and how certain industries/sectors are in or out of favor cyclically. But as someone who started investing holding onto this quote from John Burr Williams " A cow for her milk, a hen for her eggs, and a stock, by heck for her dividends. An orchard for fruit, bees for their honey, and stocks, besides for their dividends ", it is still a bit surprising that dividend paying stocks in the same industry/sector are underperforming non-dividend payers.
Speaking of dividend paying telecom stocks under-performing the market, enter Vodafone Group Public Limited Company ( VOD ), the subject of this article. Vodafone Group is a British telecommunications company that operates in 21 countries, in addition to partnering with carriers in 48 other countries. Prior to the recently announced merger with Hutchison, Vodafone was already the third-largest carrier in the UK, and the proposed deal is set to create the largest mobile firm in the UK.
While Vodafone is a well-known brand globally, the company's struggles are reflected in the stock performance, especially over the last 5 years. The stock has lost 60% of its value due as the company struggles with increasing competition, increasing need to invest, and pricing pressure. As a result, VOD currently yields more than 10%, which by and of itself is a warning sign for most common stocks outside of a few exceptions like REITs. The 10% yield is not a result of growing dividends but shrinking share price.
Since most investors tend to hold telecom stocks primarily for their dividend income, this article evaluates the strength of Vodafone's dividend. Although the company recently stood by its dividend policy, are there more signs that Vodafone is setting up for a dividend cut? The devil may be in the details.
Before we take a deep-dive into VOD's dividend safety, a few "quirks" about this stock that investors should be aware of:
- VOD is an American Depository, as Vodafone is a British multinational company trading as a financial product in the US markets.
- VOD pays dividends twice a year instead of the typical 4 times a year followed by most dividend paying companies.
- VOD's dividends are subject to currency fluctuations (not the amount that is declared by the company, but what is actually received by US investors). As a confirmation of this, the chart below shows VOD's dividend history pulled from the company's website, and you can see the dividend has stayed flat since 2019 while Seeking Alpha's dividend history page shows fluctuating payments due to currency conversion.
- Vodafone has a history of dividend cuts as investors may recall the 40% dividend cut in 2019 when the payout was reduced to 9 eurocents, which has been maintained since then.
With the basics out of the way, let us evaluate Vodafone's dividend safety.
Free Cash Flow and Earnings Per Share
For ease of calculations and consistency, from this point in the article, we will be using the annual USD equivalent of 97 cents per share for analysis. Highlighted below are Vodafone's payout ratios using Free Cash Flow ((FCF)) and Earnings Per Share ((EPS)).
- Payout Ratio using Forward EPS: Vodafone's expected EPS of 70 cents gives the stock a payout ratio of 138%. Sometimes, companies have short-term troubles (say, unforeseen expenses or losses in general) that impacts its EPS. Hence, it is prudent to see the trend over a period of time. Vodafone's EPS struggle does indeed appear like a trend, as we need to go as far back as 2018 to see a year where the company made more than the 97 cents it is currently paying in dividends.
- Payout Ratio using FCF:
- Total shares outstanding : 2.705 billion
- FCF needed to cover annual dividend commitment: $2.62 billion (that is, 2.705 billion shares times 97 cents)
- Vodafone's ((FCF)) over trailing twelve months: $9.40 billion
- Payout ratio using TTM FCF: 28% (that is, $2,62 billion divided by $9.40 billion), which sounds great from a coverage perspective.
As I've written in a few of my articles about AT&T, I prefer using FCF over EPS for capital intensive businesses, and Vodafone is no exception to that. Hence, although EPS has been under pressure for a while, I am comfortable enough based on FCF to say that the company has enough strength in regular business operations to support the hefty dividend for now.
Debt and Cash
Telecom companies tend to carry significant debt loads and Vodafone is no exception as the company carries $52.50 billion in debt as shown below, which is well below the company's 5-year average of about $67 billion. So, despite paying a hefty dividend, Vodafone has been able to retire a reasonable chunk of its debt.
In addition, with nearly $20 billion cash on hand, Vodafone's debt of $52.50 billion does not appear all that high and should comfort both investors and creditors about the company's ability to pay interest expense on debt.
In addition, Vodafone's debt to equity ratio of 0.75 is considerably lower than AT&T's 1.38 and Verizon's 1.64 . That should comfort investors that the company is not over-leveraged and is able to fund its operations primarily through its cash flow.
Outlook, Risks, and Conclusion
Vodafone's recent deal with Hutchison to create the largest mobile carrier in the UK is significant, to put it mildly. Although UK regulators have been reluctant in the past to cut down the number of carriers from four to three, Vodafone is arguing that the deal with benefit customers as the combined entity may be able to provide more access to 5G and broadband connectivity. At the very least, the deal is expected to be a net positive in the medium-term.
Overall, though, telecom is far away from being a growth sector in almost any part of the developed and even developing world. Competitors and regulators generally ensure consumers get the best deals, thereby eroding the profit margin of any particular company. In addition, being capital intensive, most telecom companies are burdened by a huge debt load.
From a valuation perspective, for a telecommunication company that has struggled to even maintain its share in most of its markets, Vodafone's stock is trading at a rich forward multiple of 13.60 as of this writing. Although AT&T and Verizon are not like-for-like comparisons as a company, as stock comparisons, they trade at a forward multiple of 6 and 7 respectively. Given all these, I rate Vodafone a "Hold" here for those who already have a position in it, as I believe the dividend is safe for now. However, I believe Vodafone is not the best of places to invest new money right now.
The biggest factors that may push Vodafone into a "Sell" rating include worsening debt situation, Hutchison deal not providing the expected synergy and/or growth in 5G installations, and worsening economic conditions in UK primarily.
Finally, I mostly agree with Seeking Alpha's dividend grades for Vodafone, except for the dividend consistency being F. Vodafone has been paying dividends consistently once you account for the fact that they send just two dividend payments per year. A confirmation of that can be seen on Seeking Alpha here and on Vodafone's website here .
What do you think about Vodafone's dividend and its Hutchison deal? Please leave your comments below.
For further details see:
Vodafone Group: Massive Yield, Not At Risk Yet