Seeking Alpha
Value, contrarian, coat tail rider, idiosyncratic research
Profile| Send Message| ()  

There are 5.9 billion mobile phone subscriptions in the world -- equivalent to 86.7% of the world population. Only 1.2 billion people have land lines.

This article is about Vodafone (VOD), the 5% dividend payer whose current subsidiaries, joint ventures, and affiliates make it the service of about 404 million customers in 30 countries around the globe. And specifically, this article is about the safety and future of the dividend.

First, let's take a look at the company's yield. From a dividend-to-price perspective, the shares are near their cheapest level relative to their dividend:

VOD Dividend Yield Chart

VOD Dividend Yield data by YCharts

Some Essentials - A Quick Note On Their ADRs

Because Vodafone is a PLC ("public limited company") under English law, the shares bought and sold on the Nasdaq are ADRs or "American depositary receipts." When you purchase Vodafone's shares under the symbol "VOD," you are getting shares equal to 10 of their English counterpart -- with full rights. Therefore, the number of shares outstanding for Vodafone, if you were purchasing them on the London Stock Exchange, is about 49,645,940,000 - when viewed from the ADR angle, that number reduced by a factor of ten, or: 4,964,594,000. Those numbers are important when calculating the market capitalization, which presently stands at about $139.75 billion.

Geographical Diversification

To illustrate the size and scope of Vodafone, we are going to borrow some graphics from its annual report. Now, because of their size, Vodafone is geographically diversified. (All images below are from pages 6 and 7 of Vodafone's 2012 Annual Report (pdf)):

This is one of the most important features of its business. A quick glance ought to be enough to display the various large holdings this company has.

Geography

Germany is, of course, one of the few northern states of the Euro still producing a current account surplus:

Vodafone is the leading provider in Germany, arguably the strongest Euro country. Italy, as one might expect, has been a source of impairment charges in 2010 and 2011 (see 2012 Annual Report page 114 for impairment charges by geography).

Unfortunately, Vodafone does not quite dominate in its home market.

Spain is in a tough place, and has been a source of impairment charges over the past two years. Over the past five years, Vodafone has increased its market share in India and has increased the number of customers it serves by over 24 million people per year -- or a population larger than the company's portion of its home market.

Verizon Wireless - The Cellco Partnership

Lastly, of course, Vodafone has a major presence in the United States through Verizon Wireless, of whom it holds 45%. (Verizon Wireless is not to be confused with Verizon Communications Inc. (VZ), which is its holding company. See my article on Verizon Communications here.)

Because Vodafone owns less than 50% of Verizon Wireless, it is not consolidated in their financial statements. You can only see its influence in the income statement line item below:

(Source: Annual Report 2012, p. 94)

Up until recently, Vodafone's ownership in Verizon Wireless was mainly passive and it merely collected equity income on the books, without receiving cash. As of this year, however, the company received a dividend of approximately $4.5 billion -- which translated into approximately £2.8 billion.

If Vodafone recorded its proportion of Verizon Wireless and its other joint ventures into its revenue, its fiscal 2012 revenue would have been approximately £74.4 billion or 60% more than its reported revenue -- this, again, is mostly from Vodafone's share of Verizon Wireless.

To continue using the beautiful Vodafone materials, one can see the diversified service revenue below:

(Source: Fact Sheet (pdf), p. 1)

The company's operating profit tells a different story however:

(Source: Fact Sheet (pdf), p. 1)

Notice the strength of the Verizon Wireless division. Remember, the company has only just begun receiving dividends from that segment. (That massive chunk of operating profit attributable to Vodafone, by the way, is why Verizon Communications has such a low net income when compared to its actual cash flow.)

Dividends

The big eye catcher about Vodafone is its 7% dividend yield. Its regular dividend yield, however, is only about 5%. Given that Vodafone has recently begun receiving dividends from its Verizon Wireless segment, perhaps we will see more special dividends. For now let us assume only the regular 5% dividend will recur. (Curiously, Vodafone mentions the word "dividend" 213 times in its Annual Report -- Verizon mentions it only 25 times.)

(Source: Annual Report 2012, p. 112)

Summing them up and ignoring the special dividend:

(in millions)

2012

2011

2010

Final Dividend

3102

2976

2731

Interim Dividend

1536

1492

1400

Total Dividend

£ 4,638

£ 4,468

£ 4,131

Therefore, Vodafone needs more than £4,638 million in FCF [1] to cover its dividends. If we consider spectrum purchases and other intangible purchases as necessary expenditures, then Vodafone had over fiscal 2012 a FCF of £4,903:

Or if we took the FCF figure given in the Annual Report, its FCF was £6.1 billion (see 2012 Annual Report, p. 11). In both my conservative FCF estimate and the FCF figure from its Annual Report, the dividends are covered. Assuming the intangible assets are necessary, then the company's dividend would be about 94% of FCF. Or, using management's numbers, the dividend would be 76% of FCF. In both cases it is covered, but not by a huge margin.

The Future Dividend

Over the past five years, Vodafone's dividend has grown about 5.3 percent per year. If we assume the price of Vodafone's shares doesn't change (or if we assumed you bought them today), and, in addition, if we assume growth in the future is similar to the growth of the past, we would see a future dividend yield along these lines:

Ex/Eff Date Cash Amount Regular Dividend Trailing Twelve Months Price Yield
11/16/2019 0.71754 2.168528176 28.15 7.70%
6/6/2019 1.450988 2.132412671 28.15 7.58%
11/16/2018 0.681425 2.059380984 28.15 7.32%
6/6/2018 1.377956 2.025083258 28.15 7.19%
11/16/2017 0.647127 1.95572743 28.15 6.95%
6/6/2017 1.308601 1.923155991 28.15 6.83%
11/16/2016 0.614555 1.857291007 28.15 6.60%
6/6/2016 1.242736 1.826358965 28.15 6.49%
11/16/2015 0.583623 1.763809124 28.15 6.27%
6/6/2015 1.180186 1.734433965 28.15 6.16%
11/16/2014 0.554248 1.675032406 28.15 5.95%
6/6/2014 1.120784 1.64713577 28.15 5.85%
11/16/2013 0.526352 1.590724032 28.15 5.65%
6/6/2013 1.064372 1.5642315 28.15 5.56%
11/16/2012 0.499859 1.5106591 28.15 5.37%
6/6/2012 1.0108 1.4855 28.15 5.28%
11/16/2011 0.4747 1.4616 28.15 5.19%
6/1/2011 0.9869 1.4426 28.15 5.12%
11/17/2010 0.4557 1.2473 28.15 4.43%
6/2/2010 0.7916 1.2292 28.15 4.37%
11/18/2009 0.4376 1.227 28.15 4.36%
6/3/2009 0.7894 1.1734 28.15 4.17%
11/19/2008 0.384 1.3762 28.15 4.89%
6/4/2008 0.9922 1.5075 28.15 5.36%
11/20/2007 0.5153 1.3868 28.15 4.93%
6/6/2007 0.8715 1.3173 28.15 4.68%
11/21/2006 0.4458 1.172 28.15 4.16%
6/7/2006 0.7262 1.1083 28.15 3.94%
11/22/2005 0.3821 0.7769 28.15 2.76%
6/1/2005 0.3948 0.7491 28.15 2.66%
11/23/2004 0.3543 0.5494 28.15 1.95%
6/2/2004 0.1951 0.3388 28.15 1.20%
6/4/2003 0.1437 0.2839 28.15 1.01%
11/20/2002 0.1402 0.2618 28.15 0.93%
6/5/2002 0.1216 0.2373 28.15 0.84%
11/20/2001 0.1157 0.2169 28.15 0.77%
6/6/2001 0.1012 28.15 0.00%
11/21/2000 0.109 28.15 0.00%
11/25/2003 0.1621 28.15 0.00%

If such a trend happens, it would be a happy situation for Vodafone shareholders. Since such yields are unlikely to last long, one might argue there is a good chance of share price appreciation given future increases in the dividend.

Stability

A dividend which represents such a high proportion of FCF ought to be qualitatively analyzed for stability. Fortunately, Vodafone makes an excellent statement on this matter:

"We generate our service revenue through the supply of calls, text messaging and data, and other services over our networks. Consumers pay for these service either via contracts (typically up to two years in length)...

These revenue models give us excellent visibility of our business. In addition, we are not reliant on single large contracts, with the top ten biggest corporate accounts representing less than 1% of annual revenue. Secondly, the majority of our services are sold in advance-reducing credit risk and generating an attractive working capital profit. Finally, our services have become such a part of our customers' everyday lives that they have become non-discretionary in nature." (Emphasis added.)

This visibility into future revenue, because of the way Vodafone's revenue is drawn from millions of individual contracts of some specified length, is a key feature of the mobile phone industry. And further, cell phones are no longer a want, they're a need.

Euro Exposure

Vodafone's exposure to the Eurozone can be seen in two ways. First, as a negative, in that there will be declines in cell phone use due to the destruction of wealth -- this effect is already seen in the impairment charges that Vodafone has taken against its segments in Italy, Spain, Greece, Portugal and Ireland. This can also be seen as a positive, in that future pessimism could potentially push the shares to a more attractive level in the future.

Valuation

Vodafone presently has a P/E of 12.85. Using IFRS Revenue figures, its P/S ratio would be 1.95. Using Vodafone's revenue figure, including its proportional stake of joint ventures and affiliates (or the £74.4 billion figure above), its P/S would be 1.21. For myself, I prefer using FCF as calculated above.

Using its 2012 Annual Report numbers: P/FCF = 14.86.

Using FCF figure less intangible purchases: P/FCF = 18.5.

Both those figures are above the average P/FCF of the DJIA (at about 13.75). That means the price per dollar of free-cash-flow is greater with Vodafone than the average of the Dow. But considering the visibility of the business provided by the use of cell phone contracts, the higher valuation may be justified.

Conclusion

Vodafone's dividend is sufficiently protected because of the qualitative characteristics of the mobile phone industry -- but the margin is small enough to warrant caution. Unlike Verizon Communications, Vodafone does not have a high P/E or P/FCF ratio -- suggesting that the company, as it stands, is not overvalued. Should the European crisis cast a shadow over the shares of Vodafone, there might be an even more attractive price for Vodafone in the future.

  1. FCF = Free-Cash-Flow = Operating Cash Flow - Capital Expenditures
Source: Vodafone: Get Paid 5% To Wade Through The Euro Crisis