Why I’ve Sold My Holding In Vodafone Group plc For This Little-Known Company

Vodafone Group plc’s (LON: VOD) growth prospects are slim but smaller peer KCOM Group PLC (LON: KCOM) looks attractive.

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vodafone

Vodafone (LSE: VOD) (NASDAQ: VOD.US) is a FTSE 100 dividend champion. Indeed, during the past few years, the company’s dividend payout has accounted for 13% of the dividends paid out by FTSE 100 companies.

However, during the past three to four years Vodafone has become increasingly reliant on income from its Verizon Wireless joint venture to bolster cash flows and support dividend payouts. Specifically, during the past three years income from Vodafone’s Verizon holding has accounted for around 50% of Vodafone’s net income.

Unfortunately, now Vodafone has disposed of its holding in Verizon, it looks as if the company will struggle to support its dividend and fund growth, so maybe it’s time to look elsewhere for a more sustainable payout.

Should we give up on Vodafone so quickly?

Vodafone has built up a reputation for reliability during the past decade and investors trust the company’s current dividend payout, so should we give up on it so quickly?

Well, the company received $130bn for its holding in Verizon, $84bn was returned to investors, $30bn is planned for network upgrades and including available debt, the company has up to $40bn, or £25bn to spend on acquisitions.

With this cash, Vodafone’s management is seeking acquisitions that are “sizeable and could transform the company”. Nevertheless, the company is currently fighting a war over deals with US firm, Liberty Global and this risks pushing up prices, increasing the chance Vodafone will overpay for deals.

In addition, Vodafone is under attack from the rise of free messaging platforms, such as WhatsApp, which are decimating traditional revenue streams such as text messaging and voice calling. We also need to consider the fact that Europe, where Vodafone generates two thirds of its revenue, is still in a deep recession, with no signs of recovery yet.

Valuation

What’s more, Vodafone’s current valuation has me worried. You see, at present Vodafone is trading at a P/E of 17 for 2014 rising, to 23 for 2015 as City estimates currently predict that pre-tax income is going to slide from £10bn during 2014, to £3.7bn for 2015.

All in all, a forward P/E of 23 looks very expensive for a company which is expecting earnings to drop 50% during the next year.

Further, City analysts expect Vodafone’s dividend payout to remain almost unchanged during the next three years — some analysts are even speculating that the payout could be cut.

Changing of the guard

Vodafone’s rich valuation and slim growth prospects have pushed me to search for other opportunities elsewhere. One of the companies I stumbled across, with many similar characteristics to Vodafone, is little-known company KCOM Group (LSE: KCOM).

KCOM has a virtual monopoly over the telecoms market in and around Hull. The company provides fixed-line and broadband packages, as well as a services and tech support for telecommunications. Actually, the company’s services division has a multi-year backlog and, thanks to this, City analysts expect the company’s earnings to grind steadily higher by 3% to 4% per annum for the next few years.

What’s more, KCOM currently looks underpriced trading at a forward P/E of 13.3 and a dividend yield of 5%. KCOM’s management has committed itself to annual 10% dividend increase for the next few years.  

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Rupert does not own any share mentioned within this article. The Motley Fool has recommended shares in KCOM Group. 

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