Vodafone shares: here’s how I saw the big dividend cut coming

Vodafone shares will be paying less income this year. Here, Edward Sheldon explains how he saw the dividend cut coming before it was announced.

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Dividend payments from Vodafone (LSE: VOD) shares are to be reduced significantly this financial year. In March, the telecoms giant advised that it plans to cut its payout for FY25 by a whopping 50% (from 9 euro cents to 4.5 cents).

I wasn’t surprised at all by this announcement. A few weeks before the cut was announced, I wrote: “I think there’s a high probability that the dividend payout will be cut in the near future.”

So, how did I predict Vodafone’s dividend cut? And are there any other FTSE companies that are at risk of a cut in the near future?

Multiple dividend red flags

There were several dividend red flags that had stood out when I’d looked at Vodafone shares in the months before the cut was announced.

The first was the dividend coverage ratio. This is the ratio of earnings per share to dividends per share.

Back in February, I noted that earnings for the year ended 31 March 2024 were expected to be around 7.3 cents. Given that Vofadone had been paying dividends of 9 cents per year, that put the dividend coverage ratio at just 0.8.

A ratio under one is a problem because it indicates that earnings won’t cover the dividend. Generally speaking, when investing for income, it’s best to look for companies that have a ratio above two.

A second red flag for me was the lack of dividend growth. For quite a few years, Vodafone had been paying that aforementioned 9 cents in dividends to its shareholders. In my experience, this pattern – where’s there’s no growth in the payout – often comes before a cut.

Another issue was the company’s huge debt pile. At 30 September, Vodafone’s net debt stood at €36.2bn. Debt can be a real landmine for income investors. That’s because, from a company’s perspective, interest payments always take priority over dividend payments.

The consensus dividend forecast also indicated that many analysts didn’t believe the payout was sustainable. When I covered the stock in February, for example, the consensus forecast for FY25 was 6.9 cents. I actually wrote: “Personally, I wouldn’t rule out a dividend cut of up to 50% given the big debt pile.

Finally, it’s worth noting that Vodafone’s dividend yield was extremely high (above 10%). When it comes to yields, it’s a good idea to remember the phrase: “If it looks too good to be true, then it probably is.”

The right move

I’ll point out that I actually think cutting the dividend is the right move for Vodafone. After the cut, the yield will still be attractive at around 5.7%.

But Vodafone will have significantly more cash to reinvest for growth or pay off debt. So, it should help the company, and its shareholders, in the long run.

More dividend cuts coming?

Looking across the FTSE 350 today, there are a few other companies that look at risk of a dividend cut.

Wealth manager abrdn is one that stands out to me. It has a low dividend coverage ratio at the moment and its payout hasn’t grown in a few years.

Housebuilder Taylor Wimpey is another company that could potentially be at risk of a cut. Earnings aren’t expected to cover last year’s dividend payout this year.

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.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone Group Public. 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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