With a current dividend of 9 euro cents per year, the Vodafone (LSE: VOD) dividend yields 6.3%. This is far higher than the majority of other FTSE 100 stocks. A high yield can indicate that the share price is too low, yet it can sometimes indicate that a dividend cut is forthcoming, or growth is extremely low or negative. So, what does it mean in this case, and would I buy Vodafone shares?
Dividend growth is often contingent on company growth. Unfortunately, Vodafone has seen extremely little of that over the past few years, with revenues falling from €47.6bn in 2017 to €43.8bn last year. Profitability has also been inconsistent. This has strained the Vodafone share price, which has fallen from 235p at the end of 2017 to its current price of 122p. The limited growth may also lead to the dividend being cut at some point, which is a risk to note.
But there are some signs that growth may be returning. Indeed, in the recent first-quarter trading update, revenue rose over 3%. There was also extremely promising news from Africa, where the number of customers rose 10% to over 180m. The Mobile Money sector in the area also rose strongly, with transaction volumes increasing 45% year-on-year. Therefore, Africa is seen as a major growth opportunity and there is hope that profits can rise. This will mean that the dividend can remain at current levels, or even rise further. If the company can achieve profits growth, the Vodafone share price is also likely to rise.
For the dividend to be paid, it is also important for companies to have a strong balance sheet. This is what worries me about Vodafone. In fact, net debt has reached over €40.5bn and this will need paid off at some point. This may be at the expense of the current dividend and Vodafone shares would likely suffer as a result.
Indeed, Vodafone is expected to have free cash flow of €5.2bn for the upcoming year, yet I feel that this will not be sufficient. This is because it also faces around €8bn of cash calls and capital expenditures are rising due to investment in the 5G network. Last year, the group also spent €2.4bn on equity dividends, which is an added expense to consider. This means that it may have to issue more debt to pay the dividend, which is a sign that the dividend is unsustainable.
Will the dividend tempt me into buying Vodafone shares?
Although 6.3% is a very strong yield, I would not buy Vodafone as a dividend stock. This is because the dividend cover looks extremely weak, and there is potential for a dividend cut. If the dividend is not cut, I believe that this would be at the expense of the rest of the business, especially if debt is used. Accordingly, I cannot see significant upside potential in Vodafone shares. The dividend is not enough to persuade me to buy.
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Stuart Blair has no position in any of the shares mentioned. 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.