Vodafone (LSE: VOD) (NASDAQ: VOD.US) shares have fallen by 16% since the start of March.
The group’s recent final results revealed the scale of the earnings shortfall facing the group after the sale of its 45% share of Verizon Wireless, and current forecasts place Vodafone shares on a forecast P/E of around 30!
In short, it doesn’t look good, and I’m not surprised that my Foolish colleague Alan Oscroft recently pegged a valuation of just 189p on Vodafone shares.
However, there are two sides to every trade — and in my view, Vodafone could be a very profitable long-term buy, as I’ll explain.
1. Yield
Vodafone paid a dividend of 11p per share last year, giving a trailing yield of 5.4%. Although this dividend is not expected to be covered by earnings over the next couple of years, this is mainly because Vodafone is planning to invest £19bn in network upgrades during that time.
In its recent results, Vodafone confirmed its intentions to grow the dividend regardless of any earnings shortfall, saying:
We intend to grow dividends per share annually, reflecting our confidence in our ability to grow cash flows in the future.
That’s a bold statement, but I suspect that Vodafone’s long-term bet on 4G and cable assets could pay off handsomely, as customers increasingly expect to be able to access all media and internet services from any device, at home or on the move.
2. Low debt
A second point in Vodafone’s favour is that it was able to reduce its net debt from around £27bn to £15bn last year, giving the firm net gearing of just 21%.
This gives Vodafone plenty of headroom for medium-term borrowing, if required, and gives it a competitive advantage over heavily indebted peers such as Telefonica, which has net gearing of 200%.
3. Book value
Vodafone’s net asset value is currently 271p per share — 32% above the firm’s current share price of 205p.
Although Vodafone’s tangible (property and equipment) assets add up to just 95p per share, this excludes the value of its spectrum, software licences and brands — all of which I believe are significant.
In my view, if Vodafone grows earnings and cash flow as it expects to, its share price will be re-rated to reflect the firm’s underlying book value — and in the meantime, long-sighted investors will have enjoyed a generous dividend income.
