With a dividend yield of 6.2%, shares in Vodafone (LSE: VOD) are understandably tempting for income investors. But there is one major question to consider: does the telecoms giant have what it takes to deliver market-beating returns for investors?
Share price down 6%
The group’s share price is down 6% from a year ago, despite steady organic growth in service revenues and improving free cash flow. Progress has been slow, but Vodafone seems to be getting there. Although overall group revenues in the last financial year dipped by 4.4%, operating profits soared by 182% to €3.7bn as free cash flow more than doubled to €4.1bn.
Continuing with the momentum into 2017, first quarter service revenues grew by 2.2% to €10.8bn, with good growth across Continental Europe — particularly in Italy and Spain, where it had come under intense pressure from price cutting by its rivals. This slow but steady progress, however, does not seem to have been well received by investors.
And it’s probably for good reasons too, given that Vodafone continues to face cut-throat competition from the industry. Its rivals are keeping prices low, while ramping up spending on new, faster networks and multi-play solutions. Vodafone is having a particularly difficult time in the UK, where it lacks its own pay-TV services — with organic service revenues there falling by 3.2%, in contrast to positive growth in its other European markets.
Add to that the big investments planned for the next few years, Vodafone seems set to face a challenging road ahead. To make matters worse, the company’s debt pile is fast rising, with net debt of £31.2bn, just while new mobile spectrum auctions are looming. This means that, looking ahead, future returns could be less than enthusiastic as these pressures crimp future dividend growth and threaten the mobile network operator’s uncertain recovery.
What’s more, valuations aren’t looking too tempting either, with shares trading on a forecast P/E of 28.
Instead Chesnara (LSE: CSN), the life and pensions consolidator, might be a better buy for dividend investors. The Preston-based company is showing good momentum following the completion of its latest acquisition, Legal and General Nederland, which has since been rebranded as Scildon.
Its Economic Value, a key measure of the insurer’s underlying worth, climbed by almost £100m in the first six months of 2017, to £700m, while group cash generation rose from £13.6m last year to £46.2m. The insurer also boasted of strong financial foundations as its solvency ratio remained resilient, at 143%, despite the impact of recent acquisitions.
Looking ahead, City analysts expect Chesnara to pay shareholders a dividend of 20p a share, which gives shareholders an appealing prospective yield of 5%. The company is highly cash generative and easily affords its annual dividends internally, with dividend cover expected to rise to nearly two times this year.
Valuations are also attractive as shares in the company trade at a 15% discount to its Economic Value, with a forward P/E of just 10.3 indicating that it offers substantial upward re-rating potential.
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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca. 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.