Vodafone (LSE:VOD) shares have been the second-worst performers in the FTSE 100 index over the past five years. The collapse in the company’s share price has pushed the dividend yield up to a massive high of 10.28%.
So is the telecoms stock now a good option for investors seeking to boost their passive income? Or is this a classic dividend trap to avoid?
Here’s my take.
Turnaround hopes
The company is expected to make an announcement imminently regarding a long-awaited merger with its rival Three in a move that would create the UK’s largest mobile operator. The newly-formed business is expected to be valued at around £15bn. Vodafone is anticipated to own a 51% stake.
This link-up could be good news for the Vodafone share price. The firm would benefit from economies of scale and deeper pockets to plough into innovation programmes. Given the UK government has ambitions for the country to become a leader in 5G technology, there’s scope for the business to deploy its greater resources in pursuit of this aim.
However, the company will have to face regulatory scrutiny first. After all, takeover attempts by Three to acquire O2 from Telefónica were blocked in 2016 by the European Commission.
Post-Brexit freedoms won’t necessarily make a successful merger more likely. The UK’s own Competition and Market Authority’s recent decision to block Microsoft‘s takeover of Activision Blizzard suggests investors should still exercise caution with regard to Vodafone’s merger hopes.
Beyond the proposed tie-up, the company is trying to streamline its operations. It recently announced plans to slash 11,000 jobs in the UK and worldwide over the next three years. This could make it more competitive and boost profits. But there’s also a concern it could impact service quality.
A risky dividend
On the face of it, one of the most attractive features of Vodafone stock is the bumper dividend yield. However, there’s a risk it could be too good to be true. Bank of America has cautioned that the company might cut its payout by 30%, bringing the yield closer to 6%.
Now, that’s still a very decent distribution. It would comfortably eclipse the average FTSE 100 yield of 3.76%. Plus, a lower yield would likely be more sustainable. Nonetheless, investors hoping for a colossal passive income haul would be wise to limit their expectations.
Vodafone’s debt-to-equity ratio of 105% is uncomfortably high. As further interest rate hikes look likely, the cost of servicing this debt could rise further. The company needs to take urgent steps to get its debt mountain under control, in my view. There’s a danger the proposed job cuts might be the tip of the iceberg in terms of the measures required.
A stock to buy?
I’ve considered buying Vodafone shares previously. The stock has a high risk/reward profile, but the merger could mark a change in its fortunes. That said, much will need to go the company’s way for a share price recovery to materialise.
If investors are considering buying, a degree of wariness about the company’s future would be prudent. When it comes to my own portfolio, I’d only be comfortable taking a small position here if I had spare cash to invest.
