6.6% yield: should I buy Vodafone shares for a passive income?

The Vodafone share price is rising after the company reported a return to growth. Roland Head asks if the stock’s high yield is safe.

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The Vodafone Group (LSE: VOD) share price rose on Friday morning, after the FTSE 100 telecoms giant issued a strong trading update.

My investing goal is to build a portfolio that provides a rising, passive income. Vodafone’s 6.6% dividend yield makes it a tempting choice, but can the company maintain, or increase, this payout over time? I’ve been taking a fresh look.

Europe is bouncing back

Vodafone’s revenue rose by 5.7% to €11,101m during the quarter to 30 June. Much of this increase seems to be driven by the reopening trade. Revenue from roaming charges rose by 56% during the period — although they were still 54% lower than before the pandemic.

Income from the group’s business customers also rose, with a 2.7% increase in service revenue.

The recovery still has a way to go, but it seems people are on the move again. I expect further gains over the next six months, assuming the pandemic continues to ease.

Africa looks exciting

I’m pleased to see Vodafone’s European operations also return to growth. But the reality is that European telecoms networks are fairly mature businesses. Populations aren’t getting much bigger and most people already have mobile and broadband services.

Looking ahead, I reckon the exciting growth opportunity is in Africa. Vodafone is one of the largest mobile operators in this market, covering 67% of the continent’s population.

The numbers are huge. Over the last year, the number of Vodafone mobile users in Africa has risen by 10% to 181.6m. By comparison, Vodafone only has 65.6m mobile customers in Europe.

The company also has another big growth engine in Africa — the M-Pesa mobile money business. In countries where many people don’t have access to banking, mobile money is big business. M-Pesa handled 4.5bn transactions during the last quarter, serving almost 50m customers.

Vodafone shares: why so cheap?

Vodafone shares offer a 6.6% dividend yield. This is much higher than most of the other big telecoms stocks on the UK market. For example, BT has a forecast yield of 4.1%. Africa-only operator Airtel Africa yields 4.3%.

A higher yield suggests Vodafone shares are rated more cheaply than rivals. Why?

Vodafone generates plenty of cash — certainly enough to support its dividend. The latest guidance from the company is for free cash flow of “at least €5.2 billion” this year. That’s enough to pay the current dividend twice over.

One problem is that Vodafone must also keep spending on new infrastructure and services. Historically, this hasn’t always been very profitable.

CEO Nick Read admits that Vodafone’s returns have not covered the group’s cost of capital in recent years. In plain English, that’s a bit like renting out your house, but not generating enough income to pay the mortgage.

Read reckons he can fix this problem by slimming down the group’s operations and adding more profitable digital services. But he still has some way to go, in my view. 

My verdict? If I wanted a good passive income today, I’d buy Vodafone shares for their 6.6% yield.

But if I was investing for a retirement income in the future, I’d look for a business with stronger growth credentials. I can see some risk that Vodafone’s dividend will be worth less in 10 years than it is today.

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.

Roland Head owns shares of Airtel Africa Plc. The Motley Fool UK has no position in any of the shares mentioned. 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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