Is Vodafone A Good Income Play?

Summary

• Vodafone has a mature business that is relatively stable over the medium-term, but growth prospects are somewhat weak.
• One of its business priorities is to reduce debt through asset sales, thus its dividend does not seem to be at risk in the short term.
• Its high dividend yield above 8% is the main reason to buy its shares.

VV Shots/iStock Editorial via Getty Images

Vodafone (NASDAQ:VOD) offers a high-dividend yield that seems to be sustainable in the next few years, while over the long term it’s not a safe income play.

Company Overview

Vodafone is a telecommunications company based in the United Kingdom, with a good business and geographical diversification across Europe and Africa. The company has some 323 million mobile customers, 28 million fixed broadband customers, and 22 million TV customers worldwide. Its market value is approximately $29 billion, and is listed on the NASDAQ through American Depositary Receipts (ADRs).

While the company is based in the U.K., it’s one of the world’s largest telecom operators, with operations in 19 markets. Its largest markets are Germany, Italy, Spain, and the U.K., which together account for more than 60% of the group’s revenue. It also has exposure to other growth markets, mainly in Africa and Asia, through subsidiaries and joint-ventures.

Beyond its core mobile and fixed broadband segments, it also has significant exposure to wireless infrastructure assets through Vantage Towers (OTCPK:VTAGY), in which Vodafone holds some 81% of its capital.

Financial Overview

Regarding its financial performance, Vodafone is a mature company and operates in a highly competitive sector, which has led to a relatively muted growth history in recent years. Indeed, over the past four fiscal years, its annual revenues have been relatively stable between €43.6-45.6 billion, showing that its growth prospects are somewhat low. Its EBITDA margin is quite good compared to its peers, given that over the past three years it has been between 32-33%, which compares favorably with other large European telecoms, such as Orange (ORAN) or Telefonica (TEF).

In its last fiscal year (FY 2022), which ended in March 2022, revenue increased by 4% to €45.6 billion, of which 83% of revenue was generated by services. This positive performance was justified by growth in most markets, including its largest market (Germany) where service revenue increased by 1.1% YoY. Other European markets also reported modest growth (+0.5% YoY), while Africa was the region with higher growth (+4.6% YoY) during FY 2022.

On the other hand, Italy and Spain were two particularly weak markets, both reporting declining service revenue in the last fiscal year of about 2% YoY, due to fierce competition that is putting pressure on prices.

On top of positive revenue growth, Vodafone is also pursuing cost cutting initiatives to improve efficiency, which led to an increase in its EBITDA of 5% YoY, to €15.2 billion. Its EBITDA margin was 33.4%, the highest level in the past few years. This is supported by Vodafone’s cost savings of €1.5 billion achieved in its European business over the past three fiscal years, through digitalization and simplification of its processes.

EBITDA (Vodafone)

Its net income amounted to €4.4 billion, an increase of almost 10% compared to the previous year, and its return on capital employed (ROCE) ratio improved to 5% (vs. 3.9% in FY 2021). Its free cash flow was €3.3 billion, ahead of what the company expected to achieve due to higher margins and business growth.

During the first half of fiscal year 2023, Vodafone maintained a robust financial performance, with service revenue reporting growth of 2.5% YoY, but profitability declined due to softness in Germany. This is the company’s largest market and recent trends have been somewhat poor, with service revenue declining in the first two quarters of the year due to customer loss and pressure on pricing.

German revenue (Vodafone)

Other markets that continued to report weak trends were Italy and Spain, which reported a decline of 2.8% YoY on service revenue and minus 4.5% YoY, respectively. On the other hand, the U.K. (+6.7% YoY) and other Europe (+2.7% YoY), were regions with better performance, while Africa maintained its positive growth trend (+4.8% YoY).

Regarding its EBITDA, it was negatively impacted by lower revenue in key markets, while cost cutting efforts were offset by rising inflationary cost pressure, leading to an EBITDA of €7.3 billion in the period (vs. €7.5 billion in the same period of FY 2022). Despite slightly lower profitability, its free cash flow was quite stable at €3.2 billion, showing that Vodafone continues to generate significant cash despite some market headwinds.

Regarding its guidance for FY 2023, it was slightly revised downwards due to challenging macroeconomic conditions, and now Vodafone expects EBITDA to be between €15-€15.2 billion (vs. €15-€15.5 billion previously) and free cash flow to be about €5.1 billion (vs. €5.3 billion before).

Going forward, according to analysts’ estimates, the company is expected to maintain a relatively stable performance, considering that revenue should be between €46-€47 billion over the next three years, while EBITDA is not expected to change much from around €15 billion per year, during the same period.

However, this seems to be quite conservative, given that Vodafone is reportedly preparing significant job cuts, aiming to slash costs by about €1 billion by 2026. Even though there are some revenue headwinds and overall inflation is leading to higher costs, these measures should have a positive effect on the company’s efficiency and a higher EBITDA than currently expected is likely to be achieved in the medium term.

Dividends

While Vodafone is a mature company and its growth prospects aren’t particularly impressive, on the other hand a great reason to consider its shares is its dividend.

Vodafone’s dividend history is mixed the past few years, as the company performed some dividend cuts, but more recently its dividend has been stable at €0.09 per share. This dividend has been paid through an interim dividend and a final dividend (€0.045 each), which at its current share price leads to a high-dividend yield above 8%.

However, this high-dividend yield can either be a great opportunity for income investors, or a warning sign that it may not be sustainable over the long term, and a dividend cut is possible over the coming years. To see if Vodafone’s dividend is sustainable, I looked at its earnings stream, cash flow coverage, and balance sheet position.

Regarding earnings, considering that Vodafone’s EPS has been €0.09 in 2021 and €0.15 in 2022, the dividend is covered by its bottom-line but the dividend payout ratio has been quite high. For fiscal year 2023, current estimates are for EPS of €0.10, thus Vodafone’s dividend payout ratio is 90%. This is a very high level and does not make me comfortable, as I would prefer a dividend payout ratio between 50-70% to consider it sustainable.

On the cash flow side, Vodafone’s annual dividend outflows have been between €2.3-€2.5 billion over the past three fiscal years, which is more than covered by its free cash flow generation of €5 billion per year. This is clearly positive for the company’s dividend sustainability, as Vodafone’s cash flow generation gives plenty of room for dividend payments in the coming years.

Lastly, Vodafone’s balance sheet is not particularly defensive, considering that is has a net debt position of €45.5 billion and a financial leverage ratio of 3.1x. This is quite high even within the telecom industry and above its own 2.5-3x target, and not surprisingly debt reduction has been one of Vodafone’s business priorities in recent months.

It recently announced a partnership with GIP and KKR to sell part of its stake in Vantage Towers, which will result in cash proceeds between €3.2-€7.1 billion, which it will use mainly to reduce debt. Moreover, it also announced the sale of its Hungarian unit for $1.8 billion, and further sales of non-core assets are possible in the coming months to support its debt reduction targets.

Conclusion

Vodafone is a mature company and has relatively weak growth prospects, explaining why it is trading at only 10x earnings. This means that the best reason to buy its shares is its high-dividend yield, which has an acceptable sustainability considering that is well covered by cash flow generation and Vodafone’s strategy to reduce debt comes mainly from asset sales, thus its dividend is not expected to be cut in the short term. This makes Vodafone an acceptable income play for the coming years, even though investors should be aware this is not a safe income play over the long term.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.