MENU

Why the Vodafone share price and 7.6% dividend yield may make it the bargain of the FTSE 100

Image source: Getty Images.

The Vodafone  (LSE: VOD) share price has performed poorly so far in 2018. It ended last year at 235p and has fallen a whopping 25%.

I saw good value in the stock at 184p in early July. The forecast 12-month price-to-earnings (P/E) ratio was 18.4 and the prospective dividend yield was 7.1%. The shares have subsequently declined further to around 176p. The P/E has come down to 17.4 and the dividend yield has risen to 7.6%. Is Vodafone now even better value or has news since July dampened my enthusiasm for it?

Sustainable dividend?

Vodafone’s dividend has always been a big part of the total return equation for investors. The current yield is higher than it’s been for many years and this makes Vodafone a strong investment proposition — if the dividend is sustainable.

Some commentators are concerned that Vodafone’s earnings haven’t been covering its dividend and that it may not be able to afford the payout in the future. However, I believe this concern is overdone. When it comes to assessing dividend affordability, accounting earnings can be less useful than free cash flow (FCF). This is the amount of cash a company has left over after paying all its operating expenses and maintenance capital expenditures.

As the table below shows, while Vodafone’s accounting earnings aren’t covering its dividend, its FCF has increased to a much healthier level, both before the costs of spectrum acquisition (part maintenance and part growth capex) and after.

  2016 2017 2018
Earnings (€bn) 1.83 2.25 3.22
FCF pre-spectrum (€bn) 1.27 4.06 5.42
FCF (€bn) (2.16) 3.32 4.04
Dividends (€bn) (4.19) (3.71) (3.92)

As you can see, FCF for the financial year ended 31 March 2018 was well ahead of earnings and covered the dividend. It’s worth noting, incidentally, that while Vodafone’s P/E is relatively elevated, its P/FCF is more attractive.

The company stated in its last annual report that investment in spectrum will be higher in the next two years. Nevertheless, on a longer view it said: “We expect that our FCF generation will — on average — continue to cover our dividend obligations.” And the board reiterated its intention to increase the dividend each year.

Strong balance sheet

Vodafone’s net debt at the last year-end was €31.5bn compared with shareholders’ equity of €67.6bn, giving gearing (net debt as a percentage of shareholders’ equity) of 47%. This level of gearing is relatively conservative. BT’s is 93% and a number of popular FTSE 100 dividend stocks have gearing of well over 100%.

Vodafone’s strong balance sheet can comfortably accommodate its agreed €18bn deal to buy cable networks in Germany and eastern Europe owned by US firm Liberty Global. The acquisition, which is subject to regulatory approval, is expected to complete in mid-2019 and should be a further driver of future FCF and dividends.

Bargain buy?

Vodafone reported intense competition in India and increased competition in Italy and Spain in a Q1 trading update last month. However, challenging conditions in some markets are almost inevitable for an international behemoth. And with the board reiterating its outlook for the full-year, I didn’t see anything in the trading update to derail Vodafone’s near-term or longer-term prospects, or to suggest that the stock isn’t a bargain.

Of course, there’s no saying whether it is the bargain of the FTSE 100 — there are other contenders — but I believe the stock has the potential to deliver a high total return for investors. As such, I rate it a ‘buy’.

Buy-And-Hold Investing

Our top analysts have highlighted five shares in the FTSE 100 in our special free report "5 Shares To Retire On". To find out the names of the shares and the reasons behind their inclusion, simply click here to view it right away!

G A Chester 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.