Last week’s numbers from FTSE 100 communications giant Vodafone (LSE: VOD) did nothing to alter my opinion that the company remains a risky buy for investors, particularly those looking to generate an income from their portfolio.
A 6.8% drop in Q3 revenues to just under €11bn highlighted just how tricky it will be to turn the company’s fortunes around, despite a reduction in mobile contract churn and signs of stability in Italy, Spain, Germany and emerging markets.
Vodafone’s stock was priced at 137p as markets closed last Friday. That’s almost 40% cheaper than one year ago and almost 65% below where the shares were valued at the height of the dotcom bubble.
You’d think that such a drop in price would mean that the shares were now in firmly in ‘bargain bin’ territory, but I still don’t think this is the case.
A price-to-earnings (P/E) ratio of 17 for this financial year feels too rich for a company that, despite attempts to streamline operations, could still struggle to grow earnings as fast as hoped if securing new licences proves more expensive than anticipated and the firm struggles to offload some of its infrastructure.
There will clearly come a time when Vodafone is worth piling into. Personally, I think this will only come after a cut to the payout is announced. The expected return of €0.15 per share (or 13p) gives a yield of 9.5%, which looks far too high when addressing the €30bn of net debt on its balance sheet should be a priority.
Given the choice, I’d still prefer to back FTSE 100 peer and EE owner BT (LSE: BT-A).
Not perfect but…
With a similarly large amount of debt on its books and a big pension deficit, the £23bn cap isn’t devoid of problems. The difference, however, is that it’s already taken action on its dividends.
BT reduced the interim payout by 5% from 4.85p to 4.62p last November. While any kind of cut is unlikely to please investors, I was actually encouraged by this move compared to the perpetual will they/won’t they? state-of-play at Vodafone.
Will the final dividend also be lowered? We might get a better idea on that when the company updates the market on Q3 trading this Thursday.
For now, however, it’s predicted that BT will return 15.2p per share in the current financial year, equating to a still-really-rather-good yield of 6.4%.
Importantly, this payout is likely to be covered 1.5 times by profits. While cover of two times profits is desirable, this is still far more secure than the cash return over at Vodafone.
Even if new CEO Philip Jansen, due to take up the post in February, does decide to cut the dividend further in order to tackle the aforementioned issues, I continue to think that this is reflected in the price of BT’s stock.
Based on it generating a predicted 25.6p earnings per share in 2018/19, the stock currently trades on 9 times earnings. While not as cheap as it once was, this still represents good value in my view, especially as returns on capital employed and operating margins are higher than at Vodafone. I also think concerns over the company losing contracts in the EU following Brexit could be overdone as the possibility of a hard departure lessens.
BT isn’t perfect but it remains a better buy for patient investors, in my opinion.
