3 Things I Learned From Reading Vodafone Group plc’s Annual Report

I’m working my way through the latest annual reports of your favourite FTSE 100 companies, looking for insights into their businesses. Today, it’s the turn of telecoms giant Vodafone (LSE: VOD) (NASDAQ: VOD.US).

There’s been a tectonic shift in Vodafone’s future since the release of the company’s annual report. Specifically, Vodafone has agreed to sell its 45% stake in US phones firm Verizon Wireless to Verizon Communications for a whopping $130bn (£84bn).

Nevertheless, the report told me much about Vodafone’s core business, and also seemed to me to be quite revealing about why Vodafone may have found the disposal of Verizon Wireless so attractive.

Cash flow and dividends

One of the first things that caught my eye was Vodafone’s new dividend policy. The previous policy, which ran for three years, had been to increase the dividend by “at least 7% per annum”. Vodafone had delivered on that — albeit at the minimum — but the new policy was far more conservative: to “at least maintain the ordinary dividend per share at current levels”.

With the subsequent announcement of the agreement to sell Verizon Wireless, I wanted to learn about Vodafone’s free cash flow and dividends without the boost from the US firm:

  2009/10 2010/11 2011/12 2012/13 2013/14
Free cash flow (£bn) 7.2 7.0 6.1 5.6 4.9 (company guidance)
Ordinary dividends paid (£bn) 4.1 4.5 4.6 4.8 5.0 (assuming no dividend cut)

As you can see, Vodafone was increasingly struggling to produce sufficient free cash flow from its core operations to cover its ordinary dividend.

Licence and spectrum payments

I also learned that the free cash flow picture was actually even worse than suggested by the table above. Free cash flow is supposed to describe cash left over after all essentials have been paid, including maintenance expenditure just to keep the business standing still.

However, Vodafone makes licence and spectrum payments — running at an average of £2bn a year — out of free cash flow. Now, arguably, as licences are finite, at least some of this expenditure is essential to keep the business merely ticking over, rather than being discretionary investment for growth.

The problem of free cash flow no longer covering dividends and licence and spectrum payments goes a good way to explaining why the dividend policy Vodafone announced was so anaemic — and perhaps also why the sale of the company’s stake in Verizon Wireless became an attractive proposition.

Overall, the things I learned about free cash flow, dividends, and licence and spectrum payments were uninspiring. However, the sale of Verizon Wireless is a game-changer — provided Vodafone spends the cash pile wisely

However, I have to tell you that the Motley Fool's chief analyst believes there's a safer blue chip than Vodafone for investors. What's more, this stock currently offers a prospective income of 5.4% and the company's intention is to grow the dividend at least in line with RPI inflation every year for the foreseeable future.

You can read our leading analyst's in-depth review of the company in question in this exclusive free report. The report comes with no obligation and can be in your inbox in seconds -- simply click here.

> G A Chester does not own any shares mentioned in this article. The Motley Fool has recommended shares in Vodafone.