There is what seems to be a safe bet on the stock exchange these days: you buy Vodafone (LSE: VOD) (NASDAQ: VOD.US) stock at around 180p, and you sell it at 210p. It has traded in that range for a few months now and currently trades at 207p.
More seriously, here at the Fool we are on the hunt for value, and here are a few reasons why downside is greater than upside for Vodafone shareholders.
250p/300p Scenario
There is talk of significant improvement in trading conditions for companies operating in the tech/media/telecoms space in Europe, where Vodafone generates the majority of its revenue and where Vodafone is targeting acquisitions of fixed-line assets.
Vodafone continues to record negative growth, albeit at a much-improved pace, for wireless organic service revenue, according to research from Royal Bank of Canada. European trends have been encouraging for 11 quarters in a row. So, Vodafone stock is still cheap and will outperform, the bulls argue.
Vodafone is faring better than in previous quarter and trends may be confirmed on Tuesday, true. Its forward dividend yield may even rise above 6%, if latest market rumours are to be trusted.
Many analysts have pencilled in a price target of between 250p and 260p.
As you may know, however, medium-term forecasts suggest little growth into 2018, which is not ideal for a business boasting thin margins. In short, there is little room for error.
100p/150p Scenario
Vodafone is a business in structural decline that could deliver value only via a change of ownership, but that’s unlikely to happen any time soon, in my opinion. The company is mopping up expensive assets in developed economies and will spend more cash on deal-making in months ahead. A large discount to its current market value should be warranted. It needs a new strategy, too.
Can the shares of Vodafone really surge above their five-year high of 250p? I don’t think so.
Rather, a price target of 150p is more reasonable based on fundamentals and forward trading multiples. That goes down to 100p if Vodafone cuts the payout. Vodafone’s main attraction is a rich dividend yield, which shouldn’t remain at current levels for long — but it probably will, and will contribute to value destruction.
First, a dividend yield at about 5.5% won’t be covered by earnings for at least a couple of years. Second, the risk is that net leverage will surge in the meantime. In fact, if acquisitions take place, Vodafone’s gross cash pile will diminish. As I argued in May, when Vodafone stock traded around its current level, investors should bear in mind that Vodafone has always struggled to deliver value in spite of significant operational changes. It’s not going to be any different this time around.
