Is Vodafone Group plc An Annuity Alternative?

Annuity giant Legal & General expects the UK annuity market to halve in size following the changes announced to pension rules in this year’s Budget.

That means that the £12bn annuity market could shrink to just £6bn — leaving an extra £6bn per year in the hands of investors, many of whom I believe are likely to invest their pensions funds in dividend stocks.

vodafoneIn this article, I’m going to look at whether Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) should be on your shortlist as a potential retirement income stock.

Is the 5% yield secure?

In its half-yearly results, Vodafone said that it intends to pay a full-year dividend of 11p per share for the 2013/14 financial year, which ended on 31 March. We’ll have to wait for the firm’s final results in May for confirmation of this, but it would be very surprising if this commitment wasn’t met.

Given this, we can say with confidence that the firm’s shares currently offer a 5.0% yield, which suggests an attractive valuation.

Weak earnings?

But here’s the uncertainty: Vodafone’s adjusted earnings per share were just 7.85p during the first half of last year, and analysts’ consensus forecasts suggest that full-year adjusted earnings will be 13p per share, barely covering its planned 11p dividend.

Analysts’ forecasts for 2014/15 are even more cautious: whereas this year’s earnings included five months’ contribution from Verizon Wireless, next year won’t. The latest consensus forecasts suggest earnings of just 9.3p per share, leaving this year’s 11p dividend uncovered.

Have cash, will spend

Thanks to the cash it received from the Verizon Wireless sale, I believe Vodafone can afford to pay a dividend that isn’t covered by earnings for a year or two, but sooner or later it will have to deliver some solid growth, or its dividend is likely to come under threat.

Personally, I believe Vodafone has a decent long-term future. However, with the telco currently embarking on an acquisition spree across Europe, there is some risk involved, as we don’t know how successful this strategy will be, nor how soon Vodafone’s core southern European mobile businesses will return to growth.

It’s also worth remembering that Vodafone has a pretty short history of dividend payments — it was only founded in 1984, and has only paid dividends since 1993. When some of today’s retirees left work, Vodafone was just an ambitious growth stock.

A better alternative

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Roland owns shares in Vodafone Group but not in any of the other companies mentioned in this article.