Vodafone cuts its dividend, but there’s a silver lining for income investors

Vodafone’s boss kept investors sweet by pledging to maintain the dividend, but this promise has been broken. But it is not all bad news: we explain why.

For some time, Vodafone’s 9% plus dividend yield has looked too good to be true – and today investors have their answer, with the firm moving to cut its dividend by 40%.

This equates to a yield of around 6%, which some investors will be happy with; but others may now be warier of the company, as new chief executive officer Nick Read pledged last November to maintain the payout.

However, its heavy share price falls over the past year – a decline of 37%, compared to a dip of 7% for the wider FTSE 100 – have proved too much, increasing Vodafone’s yield to a level that has ultimately proved too high a price to pay.

At the end of January, Vodafone’s 9.5% yield was the joint-second highest in the FTSE 100 (alongside Standard Life Aberdeen, but behind Persimmon’s 9.7% yield), which put the firm in our 2019 Dogs of the Footsie hypothetical portfolio.

The dividend has been sacrificed to free up cash to pay down debt, which in turn will give the firm more firepower to invest in 5G technology. Over the past couple of years, Vodafone has been expanding its footprint in Europe, which has increased its debt pile. This amounted to €27 billion at the end of March, a decline from €29.6 billion a year earlier.

Addressing investors, Read said that Vodafone was at a “key point of transformation” and that the dividend had been “rebased” to reduce debt. The group’s full year results reported a pre-tax loss of 2.61 billion, but adjusted earnings were in line with expectations with a 3.1% rise.

Vodafone was flagged as a dividend under pressure in our dividend danger zone series, which highlights companies where there are questions marks over whether future income payments will be made to shareholders.

One key measure our dividend danger zone screen takes into account is dividend cover – the number of times the company’s net income covers its dividend payout – and at the start of 2019 Vodafone scored poorly on this front with a cover score of 0.8 times.

As a rule of thumb, a low dividend cover score - around one times or lower - suggests dividends are vulnerable, as the company is using most if not all of its profits to fund the dividend. A figure of two or more is viewed as comfortable because it is a sign the business is not over-distributing.

Those firms that pay out more cash than they can afford risk damaging their longer-term growth prospects through lack of investment in the business. Therefore, as Richard Hunter, head of markets at interactive investor, points out, Vodafone’s dividend reduction is prudent because it means the firm is addressing its problems.

He says: “Even after the cut, the yield will remain punchy and the group has committed to returning to a progressive policy. In addition, and despite the challenges of the last year, net debt has been reduced, there are signs of margin expansion and the level of revenues remains prodigious, even if they missed expectations.

“Now that the challenges are in plain sight, perhaps investors will give consideration to some of the potential for the company, and with the market consensus remaining stubbornly at a buy, there is clearly already an optimistic following.”

Graham Spooner, investment research analyst at The Share Centre, maintains a buy recommendation for income-seeking investors. This is on the grounds the firm “may be over the worst and on the path to rebuild its financial headroom”.

He adds: “Increased competition in some markets has put pressure on revenue growth; this coupled with the high auction costs associated with 5G has reduced its financial headroom. Much of this news is already priced into the shares, with the share price hitting a five-year low yesterday (13 May).

“Read, the chief executive officer, highlights the group being at a ‘key point of transformation’, citing deepening customer engagement, accelerating digital transformation and simplifying of operations. The dividend cut should help with these goals, helping future growth and reducing debt levels.”

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Comments

Nick Read

Mr. Read has a very poor track record so far at Vodafone. He has only been at the helm for a short time and it has been a total disaster. The stock has cratored. The dividend cut and the company is still paying too much for Liberty. You assume that he can run a company and keep it from falling further! He has yet to prove that he can do anything except destroy capital! Moreover, what about this challenged Board of Directors! They do not seem to have much going on upstairs and they have no control of the spending. They need to go as well. Once this is done I will look at the new team to see if they can do better before I will invest my hard earned money. The current group has wasted my money. I now get about 3 percent dividend because I bought the stock at a higher price, wrongfully believing in Mr. Read!

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