Vodafone (LSE: VOD) reported a fall in full-year revenues yesterday after competition in its UK domestic market, as well as key growth market India, intensified. The days of rampant growth seem to be well behind Vodafone and today it’s viewed as a cash cow that pumps out dividends. The shares offer a 5.9% yield, but the cut-throat nature of its industry could result in little accompanying capital appreciation.
Vodafone could be a good income purchase, but I reckon Royal Dutch Shell (LSE: RDSB) and GlaxoSmithKline (LSE: GSK) could be better income picks today.
Smoother cash flows
GlaxoSmithKline’s core operating profit jumped 14% in the first nine months of 2016 and could grow earnings by around 30% in the full year on the back of favourable exchange rates.
In its last quarter, GSK grew vaccine sales by 20%, and consumer healthcare and pharmaceutical sales by 5% and 6% respectively. Perhaps more importantly, the company’s business model has shifted significantly following the Novartis deal completed nearly two years ago.
Glaxo swapped its oncology business for the Novartis vaccine business before the two pharma giants combined their consumer goods departments in a joint venture, forming a massive operation second in size only to Johnson & Johnson.
I believe this swap could reduce volatility in the company’s cash flows. Oncology tends to be a hit-or-miss business with a cash-hungry R&D element. Vaccines research is expensive, but once developed, the sales are predictable. Most parents will follow doctors orders and vaccinate their children. Novartis was a relatively small-time player in the vaccination world and GSK believes its significant scale in the industry could help squeeze more profit out of the swapped division.
Of course, consumer goods sales are often very stable too. Many of us will buy brands like Voltarol and Sensodyne come economic rain or shine and this defensive quality should also help fortify the dividend in tough times.
That said, the company is still heavily involved in Pharmaceuticals, a far more risky business. On the plus side, the company’s pipeline looks impressive and there’s no patent cliff to deal with. Today, the company yields a whopping 5.2%. Considering its improved business model and recovering cash flows, I believe that could be a bargain.
Can we trust in Shell?
It would be remiss of me to tout Shell as a dividend stalwart without mentioning a major caveat. In spite of being a wonderful operator with an unbroken track record of dividend payments since WW2, Shell’s profits are reliant on the oil price, a factor completely out of its control
Therefore, it could be a pretty risky income buy, as indicated by a 44% profit fall in Q4.
Why would income seekers consider the company after those aforementioned issues? Firstly, the company’s integration of BG is progressing swimmingly, with cost synergies well ahead of plan. Management noted the company was operating “at an underlying cost level that is $10bn lower than Shell and BG combined only 24 months ago“.
As a result, free cash flow-generation increased from £3.32bn in the third quarter to £5.74bn in the fourth quarter demonstrating progress. I believe this figure could recover further as the BG deal begins to bear fruit.
The company currently offers a 6.6% yield. This is well above the market average and, if cash flow improves enough for it to be considered safe, the share price could rise significantly.
