After rebranding, is Talktalk Telecom Group plc a better income stock than Vodafone Group plc?

Could Talktalk Telecom Group plc (LON: TALK) be a better income stock than Vodafone Group plc (LON:VOD)?

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Talktalk (LSE: TALK) and Vodafone (LSE: VOD) are some of the market’s best dividend stocks. The defensive nature of the companies’ businesses means that their dividends are secure for the long term. The telecommunications business isn’t cyclical and therefore managements have more clarity over cash flows, which helps them set dividends at sustainable levels.  

Yield isn’t everything 

At first glance, Talktalk looks to be the better income stock. The company’s shares currently support a dividend yield of 7.7% compared to Vodafone’s 5.3%. However, Talktalk’s high yield suggests the market believes the payout isn’t sustainable. Indeed, City analysts are only expecting the company to earn 14.5p per share for the year ending 31 March 2017, while the dividend payout will cost the group 15.7p per share. To put it another way, the payout isn’t covered by earnings per share. That said, Vodafone is also in the same situation. The company’s per share dividend is twice earnings per share.

Still, on a cash basis, Vodafone’s payout is well covered. For the 2016 financial year the company paid out £3bn to investors via dividends but generated £10.5bn in cash from operations. During Talktalk’s last financial year the company’s dividend payout cost £135m and cash generated from operations came in at £182m.

But City analysts expect Talktalk’s fortunes to improve greatly over the next few years. After last year’s hack attack, which severely dented the company’s reputation with customers, management has decided to rebrand the business. And there are already some signs that this rebranding is paying off. For the three months to the end of June, the company reported it had gained 48,000 new mobile customers and 36,000 new fibre customers. Some of these gains were offset by a loss of 32,000 TV and broadband subscribers, but overall customer growth was positive.

Off the back of Talktalk’s renewed marketing and growth drive, the City is predicting earnings per share growth of 72% for this year and 20% for the year after. Pre-tax profit is expected to expand from £14m last year to just under £200m by 2018. Talktalk’s management is targeting headline earnings before interest tax depreciation and amortisation of £320m to £360m for this year, up a double-digit percentage from last year’s reported figure of £260m.

If the company meets these lofty growth targets then perhaps the market will regain confidence in Talktalk’s dividend.

The bottom line 

So, after rebranding, Talktalk could be a better income stock than Vodafone if growth targets are hit, and there are no further setbacks. The company’s dividend yield of 7.7% is certainly extremely attractive in today’s low-interest-rate world. Still, if you don’t trust Talktalk, or you’re not willing to speculate on the company’s future growth trajectory, dependable dividend payer Vodafone might be the better choice. City analysts expect Vodafone’s earnings per share to increase 30% this year and a further 15% for the year ending 31 March 2018.

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 Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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