Should Vodafone Group plc’s shareholders be optimistic after today’s trading update?

One of the FTSE 100’s biggest companies and the world’s second largest mobile operator, Vodafone (LSE: VOD), released a trading update this morning. Did investors in the £60bn cap see signs that the business is starting to move in the right direction after so much capital expenditure over the last couple of years?

Good progress

Although revenue dropped by 4.5% in the 13 weeks to the end of June (to €13.38bn from €14.01bn the year before), the company’s group organic service revenue, which it prefers to focus on, rose by 2.2%. This was mostly due to decent performance in Africa, Asia Pacific and the Middle East. There was also better-than-expected growth of 0.3% in Europe. The news wasn’t so great in the UK however, with sales down by 3.2%.

Early indications suggest a positive reaction to the news from the market, with Vodafone’s share price rising 4.5% at the time of writing. This is quite a change from its rather lacklustre performance over the last 12 months compared to some of its FTSE 100 peers. Even a flight by investors to big, resilient, global stocks following the UK’s decision to depart the EU hadn’t benefitted the company to the same extent as, say consumer goods giant Unilever, low-beta shares such as utility National Grid or tobacco stocks like Imperial Brands. So should Fools take this rise today as a sign to start reconsidering the shares?

Jam tomorrow?

Although there are signs that Vodafone’s fortunes are slowly improving and analysts are becoming more positive on the stock, I remain unconvinced for now. The low level of dividend cover, high levels of net debt, poor record of customer service and high valuation make me think other shares are more worthy of my capital.

Dividends and debt

As the Motley Fool never ceases to remind its readers, dividend investing is a sound strategy for those wanting to build their wealth over the long term. Reinvesting these payouts back into companies that manage to consistently grow their earnings can produce superb results a few decades later. That said, this only works if these businesses are in the position to keep rewarding shareholders.  

While Vodafone’s dividend cover is forecast to improve over the next couple of years (and be at 0.63 by 2018), this is still way below a level I’m comfortable with. Ideally, this figure – the ratio of a company’s net profits to the total sum of dividends – should be at least 1.5. Predictions of growth ahead mean little when the payouts to shareholders are still being paid out of reserves. Should Vodafone run into further difficulties in the future, perhaps as a result of macroeconomic wobbles, that juicy 5% dividend yield could be the first thing to be sacrificed. Its net debt also remains frighteningly high compared to net profits. There just isn’t sufficient earnings growth going on to make me bullish on the shares.

There’s also the issue that Vodafone was recently reported as being the most complained-about network in the UK, which might explain why its UK operations have dipped. Twenty nine complaints per 100,000 customers between January and March might not concern some shareholders, but this kind of negative coverage is anathema for me, particularly as rivals Talk Mobile and EE scored far lower (eight and six respectively). 

All this suggests a forecast price-to-earnings (P/E) ratio of 35 is just too expensive for a company in this position.

Better opportunities elsewhere?

Time will tell if Vodafone is able to grow its earnings to such an extent that its finances look more secure. Right now, I'm content to funnel my cash into other opportunities.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.