The low Vodafone share price and high 9% yield looks a risky buy to me
Telecoms giant Vodafone Group(LSE: VOD) has disappointed investors again, its share price falling 2.17% after reporting a 6.8% drop in third-quarter revenues to €10.99bn. Last time Vodafone reported, in November, its share price leapt 7% as disillusioned investors recapured some of their lost faith. No such joy today.
High yield, high risk
At 141p, it now trades 36% lower than a year ago, which means it’s fallen almost six times faster than the FTSE 100, itself down 6.8% over 12 months. The business still tempts due to its whacking great 9% yield, the second highest on the index. But is that secure?
Today’s results are no disaster. Strip out foreign exchange movements, asset sales and accounting changes, organic service revenue actually rose 0.1%, even if that’s down from 0.5% in the previous quarter. Group revenues fell 5.6% in Europe to €8.1bn, and by 11.1% in the rest of the world to €2.55bn. Group CEO Nick Read was nonetheless bullish, claiming to have “executed at pace this quarter and… improved the consistency of our commercial performance.”
Mobile contract churn was lower while Read also highlighted improved customer trends in Italy and Spain, yet to translate into its financial results. Vodafone enjoyed “good growth” across its emerging markets with the exception of South Africa, “which was impacted by our pricing transformation initiatives and a challenging macroeconomic environment.”
The group is now looking to radically simplify its operating model and accelerate its digital transformation. It’s also looking to strike more partnerships to make better use of its assets. This week, Vodafone announced it wants to extend its existing UK network sharing agreement with Telefonica O2 to include 5G services, allowing it to service more customers over a wider geographic area, at lower cost.
Read said the Q3 performance underpins his confidence in the group’s full-year guidance, although investors are understandably sceptical.
Vodafone currently trades at 16 times forward earnings. I had hoped it would be cheaper, given the share price collapse. The big question is how sustainable is that yield? Cover currently stands at just 0.8, which suggests it’s at risk, as the firm cannot cover the payout from free cash flow and has to borrow money to fund the shortfall.
With net debt already nearing €30bn, against a market-cap of €42bn, the balance sheet is starting to look vulnerable. Vodafone controls 58,000 towers across Europe and is exploring opportunities to monetise those valuable assets, which include a potential sale. That would shrink the debt pile, but it then has the cost of bidding for 5G licences.
Vodafone generates just 6.1% return on capital employed (ROCE), worryingly low given that some investors won’t touch a stock below 15%. However, many of my fellow Fools remain bullish, with Peter Stephens noting that Vodafone offers both value and income benefits, especially with management standing by the dividend for now.
There are positives. Earnings per share are forecast to rise 17% in the year to 31 March 2019, and by 18% the year after. By then, cover should have improved slightly to 0.93. Today offers a lower entry price for a dividend income hero. I’m still wary though.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.