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Why I’d buy 3i Group plc and Vodafone Group plc for income

Private equity firm 3i Group (LSE: III) may not be the most obvious choice for income investors, but I believe it has a lot to offer. The group invests in two kinds of assets — mid-sized businesses in Europe, Asia and the Americas, and infrastructure projects in the UK, Europe and North America.

Thursday’s half-year results show that the value of this portfolio rose by 16% to £6,584m during the six months to 30 September. This increase reflected new private equity investments totalling £514m, plus £830m of new infrastructure assets.

What’s good

Under current chief executive Simon Borrows, 3i has developed a reputation for strong financial management and for choosing successful investments. The group sold assets worth £374m during the half year, delivering a 20% gain over their book value.

Some £78m of this cash was returned to shareholders via the interim dividend, while the remainder was used to help fund new investments.

Although the group made £572m of cash investments during the first half, most of this was funded by surplus cash. At the end of September, net debt was just £48m.

What could go wrong?

3i has had an impressive record of growth in recent years. But there are some risks. One is that the shares currently trade at 920p, 41% above their book value of 652p.

This valuation implies that the market expects the group to continue booking healthy profits on future asset sales. If this proves difficult — for example in a market crash or major recession — then the shares could fall sharply.

A second risk is that in pursuit of growth, the company will overpay for new assets or allow debt to rise to unsustainable levels.

3i’s dividend yield of 2.9% isn’t that exciting. But investing in the group provides exposure to a wide range of businesses and assets that aren’t usually available to stock market investors. This could prove a good way to diversify a long-term income portfolio.

A 5.8% yield I’d trust

Telecoms giant Vodafone Group (LSE: VOD) may finally be emerging from a period that’s seen its earnings collapse and its share price lag the FTSE 100 since March 2014.

The Newbury-based firm’s recent half-year results suggested to me that chief executive Vittorio Colao’s plan to invest in new technology and expansion is now starting to pay off.

Although group revenue fell by 4.1% to €23.1bn, operating profit rose 32% to €2bn. The group returned to the black with an after-tax profit of €1.2bn, generating earnings of 4 cents per share.

Another encouraging sign is that cash generation is improving. Net debt fell by 15% to €32bn, while free cash flow was €415m, compared to €428m for the same period last year.

Looking ahead

The group also tweaked its guidance higher for the current year. Full-year adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) is now expected to be 10% higher than last year, versus a previous forecast of 4-8%. Free cash flow before spectrum expenses is expected to “exceed €5bn”, rather than just being “around €5bn”.

Earnings are expected to rise by 17% next year. And it looks to me like Vodafone’s 5.8% dividend yield should soon be covered by the group’s profits. I think this could be a good income buy at current levels.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.