Why I’d ignore the Vodafone share price and buy this other 6%+ yielder

Rupert Hargreaves explains why he’d dump Vodafone Group plc (LON: VOD) and go looking for yield elsewhere.

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With its 8% dividend yield, Vodafone (LSE: VOD) is possibly the most attractive dividend stock in the FTSE 100.

However, despite the market-leading dividend yield, I’m not interested in the company. Below I’m going to take a look at why I am avoiding this income champion.

International challenges

Vodafone’s most significant problem by far is a lack of growth. Even though the company is one of the most globally diversified businesses in the FTSE 100, the firm never seems to be firing on all cylinders. There is always at least one region that is struggling to grow.

To streamline the business, management has pushed through some significant changes over the past 12 months. These include the merger of its Indian mobile business with local rival Idea Cellular, creating the country’s biggest telecoms operator, and the merger of TPG Telecom and Vodafone Hutchison Australia. This deal will also catapult Vodafone’s business into a position at the top of the Australian market. 

Unfortunately, these changes have failed to convince investors and the City. Year-to-date, shares in Vodafone have declined around 30% excluding dividends.

Looking at the commentary from City analysts, it appears that Vodafone’s dividend policy is driving the shares lower. The company’s total dividend distribution of €4.2bn is covered by free cash flow, but when you start factoring-in rising debt and spectrum costs, the firm’s finances start to look shaky. 

Talking of debt, this seems to be another concern in the City. The total debt is approximately €40bn, that’s excluding lease obligations and other funding requirements needed to run a global telecoms business (such as upcoming spectrum payments). With all these factors to consider, City analyst have been predicting a dividend cut for some time. 

I reckon it could only be a matter of time before management acts. Competition in the global telecommunications sector is increasing, and Vodafone is having to spend more to stay ahead of its competitors. Cash flow is coming under pressure and the group is running out of options.

On the other hand, Pendragon (LSE: PDG) looks to me to be a much better dividend investment. 

The better dividend buy? 

Avoiding a global telecommunications company in favour of a car sales group might seem like an odd choice, but I reckon there are many things to like about Pendragon as an income investment. 

For a start, the stock is cheap, changing hands at just under seven times forward earnings, compared to Vodafone’s 16. The dividend yield on offer is 6.3%, below Vodafone’s 8%, but still above the market average of 3.4%. 

Further, Pendragon’s dividend payment looks much more sustainable. Even though the City is expecting a decline of 12% in earnings per share (EPS) this year, payout cover will remain above two (2.2 times to be exact). For some comparison, Vodafone’s dividend is only covered 0.8 times by EPS. 

What’s more, Pendragon’s balance sheet is rock solid. At the end of the first half of 2018, it reported net debt of £107m. The company is expecting to receive £100m from the sale of its US business in the near future, which should reduce debt to almost zero. This cash influx will allow Pendragon to buy back stock as well as returning cash to shareholders.

Considering all of the above, it looks to be the better buy to me.

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 owns no share mentioned. The Motley Fool UK has recommended Pendragon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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