If latest articles on Seeking Alpha are any indication, it seems there is some concern among investors about Vodafone's (VOD) 8% dividend increase in the face of declining revenue. It is true that this UK-based global telecom provider has indeed had stagnant revenue and earnings for awhile, yet the group raised its dividend by 7% this year and will raise it 8% in the next. And with the Verizon Wireless sale being executed right now, the coverage ratio is somewhat up in the air. But Vodafone's American Depository Receipt, or ADR dividend is, in fact, not something investors should lose sleep over.
This article is an attempt to clear some of the confusion about Vodafone. Indeed, there are some legitimate uncertainties regarding Vodafone right now, which are especially noticeable given the stock's increasing valuation. However, Vodafone is still worth holding for those with a long time-horizon. In addition, Vodafone should be able to continue raising its dividend into the future.
CEO Vittorio Colao called the group's performance "OK minus" for the past six-month period. Group revenue was down 3.2% on an organic basis. This includes a huge 14.9% revenue decline in southern Europe and even a 3.9% revenue decline in northern and central Europe. Together, these two units make up about 70% of revenues. While emerging markets were robust, performance there was not enough to compensate for Europe's decline.
There were some encouraging points, however. Red, Vodafone's unlimited contract plan for consumers in Europe, is growing ahead of schedule. Currently, Red services 7.5 million households. By March that number will be between 11 and 12 million. With unlimited usage comes higher data consumption. Average data usage in Europe has increased to 400 MB per month. This trend is expected to intensify with Project Spring.
Project Spring is Vodafone's bid to upgrade and expand its broadband network. We now have more detail on this plan. It will cost about $11.5 billion in capital expenditure over two years. The payoff is seven years, with an expected $1.63 billion increment to cash flow per year by 2019.
This is actually part of a larger plan by Vodafone to go from a "no-nonsense" prepaid voice provider to an integrated provider of voice, data, cable and broadband. Some of Vodafone's revenue decline comes from migration of European customers out of prepaid voice and into providers with better unlimited data, broadband and cable options. With multiple devices in our lives, consumers want "one stop shopping." As a company, Vodafone must adapt to this reality.
So, in addition to Project Spring, Vodafone is making acquisitions of cable companies throughout Europe. A successful transition into a comprehensive provider of data, voice, cable and broadband will likely enable Vodafone to once again grow revenues in northern and central Europe. Steady high-single digit growth in data consumption in "rich Europe" is a strong trend that can buoy Vodafone's cash flow for years into the future.
With growth in north and central Europe, coupled with continuing expansion in the hottest global emerging markets, Vodafone should be able to once again grow cash flows and dividend increases should follow.
... Now About That Dividend
Those who are worried about the dividend coverage ratio can take heart: After the Verizon Wireless transaction is complete, shares are dispersed and buybacks underway, Vodafone's dividend coverage should be "solid," in management's words. Judging from the company's history, I would suspect that to mean its dividend will be between 70%-80% of cash flow.
When To Sell?
With ADR shares seeming to inch ever higher and revenue still drifting lower, Vodafone is not the deal it used to be. The yield has declined to 4.36% based on next year's dividends. The forward price to earnings is now at 16.31 times. That's not at all unreasonable, but it isn't cheap either, especially when we consider how much work Vodafone has ahead of it. Many are surely hanging on for the big payday of dividends and Verizon shares that will come as part of the $135 billion Verizon Wireless transaction, but I believe at least some of that expectation is now baked into the price.
This is not a call to sell (I've made that call three months ago and looked like a buffoon). I will say, however, that there are better telecom values out there with more certain growth prospects. Personally, I promised myself that I would consider selling if ADR shares reached 17 times earnings or a yield below 4%. One couldn't be blamed for taking a profit here. But overall, there is no need to be concerned about Vodafone's dividend and its valuation is still reasonable.
Additional information on ADR dividends can be found here.
Additional disclosure: I am long Vodafone for family accounts.