Is Vodafone Group plc A Safe Dividend Investment?

vodAt a share price of 198p, mobile phone and communication specialist Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) has a tasty looking forward dividend yield running at just under 6% for 2016. What more could we want from a dividend investment?

The trouble is that wafer-thin cover from earnings makes the payout look vulnerable.

Verizon leaves a whole in the finances

City analysts following Vodafone expect forward adjusted earnings to cover the dividend about 0.6 times. Ideally, we want earnings to cover the payout around twice, and if we adjusted the dividend to a theoretical level that raised earnings’ cover to two, the forward yield would be around 1.9%, which indicates how over-valued Vodafone appears to be.

However, it’s not earnings on a profit & loss statement that pay the dividend, it’s cash. Last year, ordinary dividend payments cost the firm around £5,340m. That’s a sum roughly equivalent to the annual amount Vodafone earned from its investment in US operation Verizon Wireless, which it has now sold. So, there seems to be something of a hole in the budget when it comes to maintaining the dividend at its pre-Verizon-sale level.

Yet, the directors seem committed to maintaining the dividend around its current level and expect cash flow to improve going forward.

Progress continues

Vodafone continues its deal making and partnering around the world — a string of recent announcements testify to that. Last years’ results show Europe delivering around 64% of Vodafone’s earnings, down 10%. The rest came from the fast-growing emerging markets of Africa, the Middle East and the Asia Pacific, where earnings increased 10% on the year-ago figure.

If the firm can keep emerging-market growth in double figures, more than 50% of earnings could originate in up-and-coming regions within five years, making those areas the main profit driver for the firm. Maybe Vodafone will become a faster-growing company than it is now, which could help the firm sustain its dividend. There’s also the prospect of a turnaround of the company’s fortunes in Europe contributing to firmer forward trading.

However, rolling out wider 4G coverage in Europe and 3G coverage in emerging markets takes on-going cash investment, which competes with dividend payments.

What now?

Vodafone leaves me feeling uneasy right now. Forward dividend cover has low visibility and appears to be relying on as-yet undeveloped business materialising. On top of that, at a share price of 197p, Vodafone trades on a forward earnings multiple of around 28 for 2016. There’s great potential for that multiple to contract, especially is takeover speculation starts to evaporate. If that happens, capital loss could nullify any gains from dividends.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool recommends Vodafone.