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As Vodafone returns to underlying growth, is the 6% dividend yield safer?

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FTSE 100 telecoms giant Vodafone (LSE: VOD) released its third-quarter trading update today. The company declared the business has returned to service revenue growth of 0.4% year on year. That beats a decline of 0.4% suffered in the second quarter.

The report hails this outcome as a “resilient” trading performance driven by “continued commercial momentum,” despite ongoing lockdowns.

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However, service revenue is an alternative measure designed to highlight the underlying growth in the business. And overall, total revenue declined by 0.3% in the period.

Vodafone shares are up today

The share price looks buoyant today. And at just above 131p, the dividend yield is near 6%. But the directors rebased the shareholder payment lower in 2019, which isn’t an ideal scenario for income-seeking investors. On top of that, Vodafone’s shares trade more than 40% below their level three years ago. So shareholders have suffered declining income and capital losses over the period.

One of Vodafone’s attractions is its vast infrastructure network. Competitors can’t replicate the set-up easily. But maintaining and developing the infrastructure requires vast sums of capital investment. And Vodafone must invest constantly to maintain the competitive advantage of the business.

One consequence is the big debt-load carried by the firm. And the servicing of debt interest tends to compete with the servicing of shareholder dividend payments. However, the company is reducing its ongoing costs by sharing its networks with other firms for a fee. And there’s also a strategy of investing in infrastructure via joint ventures.

A positive outlook

Chief executive Nick Read said in today’s report the recent good trading makes him “confident” in the full-year outlook. The company expects adjusted EBITDA to be between €14.4bn and €14.6bn and free cash flow to be “at least” €5bn. That anticipated cash flow performance is consistent with the five-year record. And it confirms that steady flows of incoming cash is one of Vodafone’s big strengths.

Read also mentioned the upcoming Initial Public Offering (IPO) of Vantage Towers (Vodafone’s radio tower business) in early 2021. The flotation is set to raise money for Vodafone. And Read said it will now include the firm’s 50% shareholding in its UK towers joint venture with Telefonica.

Meanwhile, City analysts following Vodafone expect overall earnings to increase by just over 30% for the trading year to March 2022. That will raise the cover for the anticipated dividend to just over one. I like to see higher cover from earnings. But, in the case of Vodafone, free cash flow has historically covered the shareholder payment well. Nevertheless, cover from free cash didn’t prevent the recent cut in the dividend.

On balance, I think the outlook for ongoing shareholder dividend payments improved a little today. But Vodafone isn’t the only high-yielding investment I’d consider in the FTSE 100 right now. For example, I’d also run the calculator over companies such as GlaxoSmithKline, British American Tobacco and National Grid.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has recommended GlaxoSmithKline. 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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