A few years ago, I thought Vodafone (LSE: VOD) was a mess. It seemed to be a collection of disparate telecoms companies around the globe, with no obvious overall direction. The company was also paying big dividends, nowhere near covered by earnings. And to cap it all, I thought the Vodafone share price was way too high.
I think that situation has improved in a number of ways now.
The company finally gave in and slashed its dividend, although I see the move as half-baked. Earnings fell at the same time, and still don’t cover the reduced dividend. Forecasts suggest Vodafone will achieve dividend cover, but not until 2022. And even then, earnings will only just be sufficient for marginal cover.
With the current Vodafone share price, forecast dividends would yield more than 7.5%. I find the reasoning behind that policy incomprehensible. Vodafone could slash the dividend by half and still pay a decent yield – and save cash for future growth.
Rising debt
Vodafone’s big, and growing, debt pile compounds the problem. At 31 March, net debt stood at more than €42bn, up from €27bn a year previously. In that year, Vodafone’s net debt to adjusted EBITDA multiple climbed from 1.9 times to 2.8 times. It makes sense for Vodafone to use debt funding, and it has no shortage of lenders. And it does need massive capital for the ongoing 5G rollout. But I think debt has gone way too high, and it’s undoubtedly weighing on the Vodafone share price.
Still, at least I do see some focus these days, with the company divesting non-core businesses and directing its efforts towards the 5G rollout. Vodafone’s latest update, regarding the disposal of Vodafone Egypt, is a step in that direction. The firm has “substantively completed” due diligence over the sale of its 55% stake to Saudi Telecom. The two parties should hopefully finalise it before too much longer.
Vodafone share price
My biggest problem has become a thing of the past now. It’s the Vodafone share price, which has lost 50% of its value in five years. Back in 2016, Vodafone shares were trading on a price-to-earnings multiple of 40. That would perhaps be justified for a small growth company with a stellar medium-term outlook. But while Vodafone surely does have growth prospects, it needs a lot of capital expenditure to achieve it. I thought that valuation was just plain crazy.
Vodafone has had a couple of tough years for earnings, but analysts have growth back on the cards. It would drop that P/E to only around 12 on March 2022 forecasts. That’s the lowest it’s been for a long time, and I’m now convinced it’s too low. Even at the March 2019 year-end and Vodafone’s earnings crunch, the shares had only fallen to a still above average P/E of 19.
While the earnings outlook has since improved dramatically, the Vodafone share price has fallen further. Even with the debt problem, and what I see as excessive dividend payments, I rate Vodafone a long-term buy now.
