In December, I wrote about Vodafone Group (LSE: VOD) and suggested the stock as a high yield income buy. I still think this telecoms giant is a good buy for dividend income, with a yield of about 5.3%.
However, if you’re looking for a business with the potential to deliver growth and income, I’m not sure the FTSE 100 heavyweight is the right choice.
Today I want to explain why I think growth investors should avoid Vodafone and consider a smaller rival from the FTSE 250.
Less is more
Sometimes less is more. Companies can become too big and unwieldy to operate efficiently. Arguably, this is what’s happened to telecoms giant Vodafone Group (LSE: VOD) over the years. Along the way, the group has also become quite heavily indebted.
Chief executive Nick Read is working hard to fix these problems. He’s focusing the group on its core businesses in Europe and certain regions of Africa, and selling non-core assets such as Vodafone New Zealand. Over the next few years, Mr Read also plans to float the group’s mobile tower business. This should raise much-needed cash for debt reduction.
There’s just one problem
All of this looks sensible to me. But a deal announced this week highlighted one of the risks with this approach. Vodafone has agreed to sell its 55% stake in Vodafone Egypt to the Saudi Telecom Company. Geographically, it’s a good fit. The $2.4bn price tag looks fair, too, pricing the business at seven times adjusted cash profits.
The problem is that Egypt was one of the group’s fastest-growing markets last year, with revenue growth of 14.7%. In contrast, revenue fell by 2.4% in the group’s core Western Europe markets.
Recent trading suggests these European markets are returning to growth. But competition is intense and there’s no shortage of network capacity. I can’t see Vodafone’s European business growing quickly anytime soon.
For this reason, I think Vodafone is best viewed as a mature dividend stock. If you’re looking for growth in the telecoms sector, I’d consider my next pick instead.
Do one thing well
FTSE 250 firm TalkTalk Telecom Group (LSE: TALK) has a much simpler and more focused business model. Its aim is to become the leading provider of good value broadband services in the UK.
TalkTalk was spun out of the Carphone Warehouse business founded by Sir Charles Dunstone. In 2017 Dunstone took charge of TalkTalk as executive chair and has since built up a shareholding of nearly 30%.
It’s taken a while for the group’s performance to improve and debt levels remain high. But results are slowly starting to arrive. Headline cash profits rose by 14% to £115m during the first half of last year.
In an update today, TalkTalk said that average revenue per user had returned to growth, rising by 0.6% to £24.43 per month during the final three months of 2019.
Looking ahead, TalkTalk shares appear to be fully priced, on about 20 times 202o–21 forecast earnings. The dividend yield is low too, at just 2.2%. However, I think we could soon start to see the benefits of the firm’s focused, low-cost strategy. I believe results could improve significantly over the coming years and view this stock as a potential growth play.
