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Shares I sold: Vodafone out of favour

Vodafone plans to cut its dividend by 40 per cent
May 22, 2019

Robin Geffen, manager of Neptune Income Fund (GB00B8L7B355), explains why he sold Vodafone (VOD) and what investors can learn from its decision to cut its dividend.

 

“Vodafone, one of the most important and popular income stocks in the UK, is to cut its dividend by 40 per cent as a result of high debt levels and the costly effect of 5G rollout,” says Mr Geffen. “The share price [had already fallen this year] as investors became increasingly concerned about its dividend and overall leverage – and the risk is that this trend continues.

“We sold the stock [out of] Neptune Income early last year. Vodafone had unsustainable leverage on its balance sheet which was built up to fund inorganic expansion. And a new breed of agile companies were disrupting its business model and changing pricing structures, meaning investors could no longer rely on Vodafone to provide sustainable dividends and capital appreciation. Vodafone was entering a difficult operating backdrop with limited capital available to react to changes in its competitive landscape and meet its capital expenditure requirements.

“Our approach is to deliver an attractive yield and a growing income stream while protecting capital. We are fully aware of the challenging environment for UK income investors, with the FTSE All-Share Index’s payout ratio increasing to unsustainable levels. On top of that, it is a highly concentrated market, with just 10 companies - one of which is Vodafone - producing around 50 per cent of the index’s yield. Given these challenges, it is highly important to try to protect income and capital, and not chase yield.

"The dangers of [loading up on a small number of high-yielding stocks] are shown by the impact Vodafone’s dividend cut has had on the market as a whole. We estimate that the stock’s 40 per cent dividend cut will reduce the FTSE All-Share Index’s yield by 1.65 per cent and the overall Investment Association UK Equity Income fund sector’s yield by 1.11 per cent. 

"This illustrates the disproportionate effect a dividend cut by a popular stock can have on the UK income market. Vodafone’s announcement should be viewed as a canary in the coal mine moment for UK equity income investors because we think many other supposedly safe UK dividend-paying companies may follow suit as a result of falling levels of dividend cover. We would put tobacco majors Imperial Brands (IMB) and British American Tobacco (BATS), BT (BT.A), and the major utilities stocks into that category.

“Chasing yield in the current environment is dangerous so investors must focus on companies that are growing earnings and can easily cover their dividends, to make sure their own income streams and capital are protected.”