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Income signals from Vodafone

INCOME STOCK OF THE YEAR: Although Vodafone competes in tough markets, its shares offer healthy income prospects
January 4, 2013

Save for China Mobile, Vodafone is the world's largest mobile phone operator as measured by subscribers. For shareholders, strong free cash flow has funded impressive dividends. Indeed, with a dividend yield of over 6 per cent on offer, Vodafone is one of the most attractive income stocks in the FTSE 100 index. The question for income-minded investors is whether Vodafone can continue delivering attractive returns? We think it can, which makes its shares especially attractive against today's backdrop of ultra-low interest rates.

IC TIP: Buy at 158p
Tip style
Income
Risk rating
Low
Timescale
Long Term
Bull points
  • Strong free cash flow
  • Verizon Wireless growth
  • Mobile data revenues rising
  • Dividend track record
Bear points
  • Pressures in southern Europe
  • Cost of new spectrum
  • Future dividend policies uncertain
  • Verizon Wireless payments not guaranteed

For a start, under chief executive Vittorio Colao, Vodafone has a great track record of returning money to shareholders. Through a mixture of share buybacks and dividends, it has returned £21.2bn since September 2010. This includes last year’s special dividend of £2bn, which was paid from a £2.9bn dividend that Vodafone received from Verizon Wireless, the largest mobile operator in the US (in which Vodafone holds a 45 per cent stake).

But can the good times continue? Back in May 2010 Vodafone pledged to raise dividends by at least 7 per cent a year, yet that policy expires in March. Meanwhile, revenues are being squeezed by competitive and regulatory pressures, and in southern Europe Vodafone's operations are creaking under the macroeconomic strain. Big cash outlays are looming, too. A NZ$840m (£429m) deal to acquire the spectrum of TelstraClear was approved by New Zealand's telecoms regulator in October. In the UK, an auction of wireless frequencies suitable for LTE - a superfast mobile broadband technology - is scheduled for the new year.

 

 

For all that, Mr Colao expects free cash flow for 2012-13 to be between £5.3bn and £5.8bn, as he indicated in May, albeit at the lower end. That means 2012-13’s dividend – costing about £4.8bn, based on broker Morgan Stanley's forecast payout - will be only just covered by free cash from operations. However, thanks to another dividend from Verizon Wireless - which is not part of operating cash flow - Vodafone has much more leeway. Of the £2.4bn payment announced in November, Vodafone says £1.5bn will be allocated for share buybacks. That leaves £0.9bn to help cover dividends and spectrum purchases.

With EPS in the 15p-16p range, Morgan Stanley thinks a dividend of around 10p is certainly sustainable. So, taking the broker's modest increase in dividends to 10.4p for 2013-14, that year's yield would be 6.6 per cent on current prices. At 210p, Morgan Stanley's 'target price', the yield falls just shy of a respectable 5 per cent.

VODAFONE (VOD)

ORD PRICE:158pMARKET VALUE:£77.7bn
TOUCH:157.5-158p12M HIGH / LOW:192p155p
DIVIDEND YIELD:6.5%PE RATIO:10
NET ASSET VALUE:141pNET DEBT:44%

Year to 31 MarTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
200941.04.195.87.77
201044.58.6716.48.31
201145.99.5015.28.90
201246.49.5513.79.52†
2013*44.110.3215.910.2
% change-5+8+7

NMS:15,000

Matched Bargain Trading

BETA:0.68

* Morgan Stanley estimates (EPS not comparable with historic figures) † excludes special dividend of 4p

Yet dividends may very well be higher, assuming more special payouts from Verizon Wireless. Although payment decisions are made in the US, the good news is that Verizon Wireless’s cash position is going from strength to strength. After completing a near-nationwide rollout of super-fast mobile infrastructure, the US mobile operator is benefitting from a surge in popularity for LTE-enabled smartphones and more expensive mobile data packages. In the first half, Verizon Wireless’s free cash flow jumped 24 per cent to $8.5bn (£5.3bn). So bringing Vodafone's share of that cash flow into the reckoning, Vodafone generates between £7.5bn and £8bn cash each year. Mr Calao is confident Vodafone will continue to benefit from any future Verizon Wireless growth. "When cash spikes up, cash gets paid," he says.

There are other encouraging signs. For one thing, LTE – a nascent technology in Europe – promises to increase average revenue per user. In Milan and Rome, where Vodafone has launched LTE, connecting PCs and tablets to superfast mobile broadband is priced €10 higher than slower third-generation (3G) networks. And growth in mobile internet use over 3G is helping to offset declines in voice revenues, rising 15 per cent in the first half to give an annualised run rate of £6.5bn. Strong performances in India and other emerging markets are also compensating for the downturn in southern Europe. Moreover, a cost-cutting programme is in place, which aims to strip £300m from spending on European operations in 2013-14.