Vodafone 6% yielder $VOD

There are many investors looking for a good yielding stock that beats the regular 5 year fixed deposit rates.

And what better company then a telecom giant. Telecom companies are good cash flow generators and do better than thee average market during recession.

One such stock is Vodafone, which Is the second biggest telecom company in the world. Vodafone have a footprint in Europe, South Africa, Africa, Australia and turkey.

Vodafone makes a great stock for many international investors because it is listed In UK, which have no dividend withholding tax. This means that you are not overly penalized by taxes and thus the country is a good hunting ground for yield investors.

Recent bad results

Vodafone just announced their first half results not too long ago. Two days prior to the announcement, Verizon wireless, which is 45% owned by Vodafone, announced that they will be distributing 2.4 bil in cash flow to Vodafone. This caused a 2% share price run up in a single day. Then they announced a poor set of first half earnings, which include a large write down of their Spain and Italy telecom business. This sent the stock price to a year low. Year to date Vodafone have lost 11% since the start of the year.

A global telecom player

Investing in Vodafone is pretty similar too investing in Singtel in that they are telecom company that have footprint globally. The focus of Singtel is in many emerging market region as well as Australia, while Vodafone have a large stake in emerging markets telecom but also developed Europe.

There lies the problem. Having a diversified telecom portfolio provides you many opportunities to monetize a large consumer base but also at the same time expose you to more risks.

In the case of Singtel, they have to contend with competition and regulations in India and Australia, Vodafone have to contend with a economic slowing or shrinking Europe, competitive Australia and regulatory and competitive India.

A review of the first half results show that revenues are declining rapidly in almost all European countries sans Germany, and even ten Germany is slowing as well.

The investor will wonder whether this is an opportunity or a value trap.

Historical Price Movements

Vodafone 6% yielder $VOD TTzim

The share price (this is the ADR shares listed on NASDAQ instead of London Stock Exchange) have come down a lot since the boom years in 2007-2008. It reached a low of 15 bucks, which looks an absolute bargain if you managed to snag some. The yield now would have been 9.8%.

The region around 24.50 to 25.00 looks to be the strong support. A break below this level may suggest greater downside.

Earnings and cash flow

Earnings have taken a hit from the impairment write down. However the main concern is the falling revenue from Portugal, Spain, Italy and Australia.

Vodafone 6% yielder $VOD LJemb

Spain and Italy have a been a major contributor to the bottom line and now with this problem the question is will the emerging markets which have been doing well up till now be affected.

There are forecast that Europe growth will be allowed for the next 15 years. Should there not be a catalyst to tap the large number of consumers to create new revenue stream, Vodafone may stagnate in earnings.

Vodafone 6% yielder $VOD 0cuDY

It should be made known that telecom companies, which plays out good dividends are very focus to report free cash flow (operating cash flow – capital expenditure).

Vodafone reported a weaker 2.2 bil in free cash flow. This does not include contribution from Verizon wireless.

It is good to forecast without Verizon wireless cash flow because Verizon do not have a consistent div policy. Essentially, Verizon parent may be using this withholding of cash flow so as to pressure Vodafone to sell.

Investors interested in Vodafone would be wiser looking at the cash flow distribution from Verizon Wireless as a “good to have”.

Vodafone have forecast full year free cash flow to reach 5.3 bil. This looks very far off from the 2.2 bil for the half year.

During the conference call, it was updated that capital expenditure usually takes place during the fourth quarter and are paid in next year’s first quarter so as such it make first half free cash flow looks worse then the second year.

With the deteriorating problems in Europe Australia and India, management must have some degree of confidence to guide this figure.

Will 5.3 bil free cash flow be enough to pay its current 6% dividend yield?

Total cash flow required to pay $1.53 of dividend in pounds is equal to 1.53 x 4.92 bil outstanding shares / 1.6 (exchange rate difference between USD and GBP) = 4.7 bil

This seem to indicate, without Verizon Wireless cash flow, Vodafone can still pay the 6% yield.

Vodafone indicate for next year they are likely to raise dividend by 7%. How much cash flow would that require?

Simply, they should require 4.7 bil x 1.07 = 5 bil. It looks like we can look forward to a 6.5% yield next year.

Leverage

Vodafone have a net increase of 2 bil debt increase year on year.

Net debt to asset is 31 bil / 130 bil = 23%. They don’t look like overly leverage.

However, their balance sheet does have 30 nil worth of goodwill, which essentially are not assets of any value.

Taking that into consideration, the net debt to tangible asset becomes 31bil / 100 bil = 31%. It still looks a good figure.

The only part that I don’t like is that cost of debt have risen to 5.5% from 4.8%. Now if you have equity yielding at 6% and debt yielding at 5.5% which would you choose?

Frankly speaking I would have chosen the debt!

Valuation

Enterprise Value = $35.4 bil + $77 bil – $4.2 bil = $108.2 bil

EBITDA forecast = $12 bil

EV/EBITDA = 9 times

9 times do not look cheap but neither overly expensive. A telecom is really cheap if you can buy the cash flow for less than 6 times.

No dividend withholding tax

Since Vodafone is based in UK, the dividends paid out are not subjected to high dividend with holding tax.

This would mean that sans processing fees, what you see is what you get.

Conclusion

I am somewhat skeptical about the dividend investing story that gotten real hot recently. At the same time, I fear that upside for telecom operators are capped.

The large number of subscribers are a good area for the  firm to think about how to monetize them. However, Vodafone would really need to be innovative to take advantage of this data wave.

I hold the view that any new areas ventured, would just be to make up for the loss revenue due to lower SMS.

Still, I will be comparing Vodafone against prospective 6% yielders. We are looking at the highest return pre unit risk.

For 6% yield, you have Ascendas REIT, First REIT,CMPacific, Boustead and Kingsmen to compare against.

I run a free Singapore Dividend Stock Tracker . It  contains Singapore’s top dividend stocks both blue chip and high yield stock that are great for high yield investing. Do follow my Dividend Stock Tracker which is updated nightly  here.

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