As a keen income investor, I’m finding it hard to ignore Vodafone (LSE: VOD) shares at the moment.
This FTSE 100 stock’s plummeting performance has left the shares offering a dividend yield of 10.8%, based on last year’s payout. I’m tempted by the income.
But the market’s harsh view of the stock — down 40% in a year — suggests to me that problems may lie ahead. Should I take the risk? I’ve been taking a fresh look.
A turning point?
Vodafone’s original vision was to bulk up so it could benefit from economies of scale. The group owns major networks in much of Europe and is also one of the largest operators in Africa.
But while I like the faster-growing African business, this story just hasn’t worked out in Europe.
The world has moved on since the early 2000s. Mobile operators face tough competition and continual demand for increased data capacity. Vodafone is huge, but its returns on capital are too low. In short, it’s just not profitable enough.
The need to continue investing in its networks — over €8bn a year more recently — has left the group with a lot of debt and a stretched dividend.
Time to break up?
City analysts believe the group could be worth more if it was broken up. New chief executive Margherita Della Valle has made some early moves in that direction.
In the UK, she’s agreed the outline of a merger with rival network Three. If the deal is approved by the regulator, the combined business would have a 30% market share and could generate cost savings of up to £700m a year.
Vodafone has also agreed a roaming deal with smaller rival 1&1 in Germany and is continuing to sell down its stake in the Vantage Towers business. This has raised €5.4bn, so far.
Job cuts are also underway — 11,000, in total. Alongside this, Della Valle plans to give regional divisions more independence. I reckon these measures could help to lift profit margins.
Is the dividend still safe?
Vodafone’s first-quarter results covered the three months to 30 June and showed some signs of improvement. Service revenue rose by 3.7% during the period, excluding the impact of exchange rates.
In Vodafone Business, which is one of the more profitable parts of the group, service revenue rose 4.5%. In Africa, service revenue was up 9%.
Della Valle left profit guidance for the year unchanged in July’s update. As things stand, my sums suggest the dividend remains affordable, but only just.
I think there’s still some risk of a dividend cut. But if I was looking to invest in a turnaround situation, I might consider Vodafone.
Two big industry investors have bought stakes in the group over the last couple of years. I reckon they must see some value in the group’s assets.
I also believe that Vodafone has some good assets that are attractively valued. In my view, we may finally be getting close to the time when some of that value is released for shareholders.
