Dividend policy: Vodafone intends to grow full-year dividends, paid in euros, annually
Yield: 5.9 per cent
Payment: Paid in euros, annually
Last dividend cut: Vodafone’s annual payout has increased every year since 1990 when it first paid a dividend
Not long ago, Vodafone’s (VOD) significant restructuring strategy made it a prime candidate for a potential dividend cut. In 2013, the telecoms company – Britain’s largest – disposed of its US business, whose principal asset was a 45 per cent stake in peer Verizon Wireless. The year before its disposal, Verizon had earned Vodafone £6.4bn-worth of profits, more than half of the group’s overall adjusted operating profit. The year after, Vodafone began its £19bn ‘Project Spring’ investment programme. Unsurprisingly, by the financial year ended March 2016, Vodafone’s adjusted earnings per share had dropped to 5p, from 18p just two years earlier. Stripping out one-offs, including gains from the disposal of Verizon, and Vodafone’s dividend has not been covered by earnings since 2012.
Free cash flows have not been much more reassuring. Sure, the group’s reported free cash flow covered its total dividend payout in every year of the past decade (except 2015), but that is only after stripping out spectrum and licensing costs. However, investment in mobile network capabilities is surely crucial for a telecoms company, particularly one with the scale of Vodafone and we would argue that they should therefore be retained in the cash flow statement. Include these costs – which averaged £5.9bn in the past four years – and free cash flow has not covered the dividend since 2012.
With such a plethora of concerns, it is perhaps unsurprising that Vodafone’s dividend has yielded close to 6 per cent in the past few years: investors have certainly not been confident in its sustainability. Looking at future earnings and the outlook is not much improved: forecasts from broker JP Morgan don’t have the dividend covered by adjusted earnings until 2020.
That said, the capital-intensive Project Spring investment scheme has now been completed, which helped to normalise capex to €7.7bn (£6.8bn) in the year to March 2017. As a result, reported free cash flow rose 219 per cent to €4.1bn and this is expected to climb to €5bn in the current financial year. However, once again this figure does not acknowledge spectrum, licensing and restructuring investments. With highly competitive auctions for both 4G and 5G coverage expected before the end of the current financial year, spectrum costs could well be hefty.
Vodafone's leverage is still high
But there are signs of improvement in some of the group’s key markets. Trading in Europe – almost three-quarters of revenue from continuing operations – is expected to improve as the drag from the abolition of roaming charges begins to normalise. Meanwhile, in the UK, the outlook is much improved. The last financial year’s problems were down to internal issues rather than any structural market challenges and management has forecast a return to growth this year, with cash profits expected to rise by between 4 per cent and 8 per cent.
It is also good news that Vodafone has managed to lessen the drag from its Indian subsidiary, whose massive spectrum requirements had caused a considerable capex drag in recent years. Brokers at JP Morgan expect the merger of Vodafone India and its peer Idea to be cash flow neutral in the first year, but up to 10 per cent accretive in the long term as the group’s share of profits increases. More importantly the merger is set to reduce debt by about €8bn. In 2017, net debt had come down slightly thanks to the improvement in free cash flow but – at €31bn – was still a whopping 2.2 times cash profits. Without India, management expects net debt to fall below two times cash profits.
