Over the past 12 months, the Vodafone (LSE: VOD) share price has slumped. Holders have seen the value of their investment fall by nearly 30% excluding dividends over this period. Including payments to shareholders, the stock has returned -22.3%, which is marginally better, but still a double-digit underperformance vs. the FTSE 100 over the same period.
And it looks as if the stock’s weakness can be traced back to one factor, the sustainability of Vodafone’s dividend.
Shares in Vodafone have always traded on the company’s dividend. Because its earnings tend to fluctuate wildly due to spectrum auction payments and capital spending obligations, the firm’s annual dividend payment has proved itself to be a more reliable indicator of value.
For example, over the past few years, the dividend yield has averaged between 7% and 5% while the company’s reported earnings per share (EPS) figure has bounced around between -€0.20 and €0.50. Over the same period, the annual dividend has held steady at approximately €0.15 per share.
However, after sliding 30% over the past 12 months, the stock now supports a dividend yield of 8.6% — more than twice the market average.
This view seems to reflect the City’s opinion that Vodafone will have to cut its dividend at some point in the next few years. Going down this path might disappoint income investors, but it would free up resources to pay down debt and invest in what one group of analysts calls, “projects that might enhance earnings growth organically.“
Time to cut the payout?
The catalyst that has ignited dividend cut chatter is Vodafone’s deal with Liberty Global.
It is paying a total of €19bn for Liberty Global’s cable networks in Germany and eastern Europe. This deal, the largest Vodafone has committed itself to since 2000, will boost EPS although group debt will spike. And this is what analysts are worried about. They estimate that after the deal, Vodafone’s debt will be 3.3x operating cash flow (excluding capital spending and dividend payments). The City believes that if the company does not cut its dividend, debt will remain at this level for years, limiting the group’s ability to invest in new projects. If Vodafone isn’t investing in new tech like 5G, customers might start walking away.
Personally, a cut might be the best course of action. It might be bad for income seekers in the short term, but I reckon the reduction would put the business on a stable long-term footing.
Considering all of the above, I’m cautiously optimistic about the outlook for the company. If the dividend is reduced, the stock could fall further from current levels. If not, rumours could haunt the business for some time, which would cap further gains. The good news is, right now, after recent declines, even if the annual payout were cut by 50% to €0.07, Vodafone would still support a market-beating dividend yield of 3.9%.
So, if it is income you’re after, whatever course of action the company decides on, Vodafone will remain one of the FTSE 100’s best income stocks.
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Rupert Hargreaves owns no share 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.