Vodafone, the high-yield conundrum

Shareholders of Vodafone (VOD) have had a rough few years, in fact, you’d have to go back more than a decade to see a decent period of upward trend in the share price. I’ve been following Vodafone (VOD) shares for many years, perhaps even 20 years and I know I’ve bought and sold these numerous times over the years. My current holding is pushing four years old, having bought in on three separate occasions between May 2020 and May 2021. My average purchase price is around £1.27, meaning I’m currently nursing a severe headache at almost a 50% loss in share value. This is by far my worst-performing investment and if it wasn’t for the generous yield (currently more than 11%) I would have pulled the plug a long time ago.

However, a decent yield cannot be the only reason to hold a share as this could be reduced or removed. I need to decide on Vodafone quickly, 2023 was a great year for a lot of my other investments and I can’t help but think that if I’d thought about this a year ago I could have easily made these losses back (hindsight hey).

Vodafone was once a great growth story but in recent times they’ve struggled to manage costs and debt in a bitter combination with a stagnant income. They’ve been selling off chunks of the Vodafone family including Vantage Towers, and businesses in Hungary and Ghana, they’ve also agreed to sell the Spanish part of the business to Zegona for up to €5bn, this is expected to go through before mid-year. Now this is all part of a plan to reduce the largely unprofitable European businesses and is being continued by the new chief executive Margherita Della Valle, having stepped up from chief financial officer in April last year. Oh, also, on top of all of this, they’re attempting to merge their domestic business with CK Hutchison-owned Three UK. The deal is currently being looked into heavily by The Competition and Markets Authority (CMA) in the UK so we will have to wait and see on this one.

It’s pointless to dwell on the losses I’m suffering right now 😭, let’s look at the company as it is today and then based on this decide whether to take my money elsewhere or perhaps hold and hope they don’t drop further (and also keep paying out the hefty dividend), maybe I’ll even purchase another slice, therefore reducing my average purchase price and take advantage of a (potentially risky but) decent dividend payout. So, let’s look at some value-based metrics…

A VALUE-BASED TABLE…

So, the above taken at face value seems crazy. Why isn’t everybody buying these shares? That dividend of 7.71p (more than 11%) seems extremely safe if this is covered by over four times (earnings per share at almost 33p), but if you scratch the surface a little… that dividend is currently costing Vodafone over £2bn per year and this is being partially funded by the aforementioned disposals. The sale of the Spanish business would cover this for around two and half years but you can’t keep funding dividend payments via selling off chunks of your business, eventually, something has to give.

Also, the yield is only this high due to the reduction in share price but there is only so far Vodafone can keep going with this, disposals are making the business smaller with potentially fewer opportunities for profit. Yes, consolidation is key to reducing outgoings (and Vodafone is looking to reduce headcount by 11,000 over the next couple of years) but they will struggle to maintain the shareholder payments unless they can increase profitability.

The P/E ratio is again ridiculous but the disposals are also skewing this, just for context a P/E of less than 10 would normally be an indication of good value for a company like Vodafone (in my opinion). The book value, however, is interesting as in theory for 67p you are buying over £2 worth of assets. Still, I suppose if they keep on paying out the hefty dividend and can’t turn the business around this will slowly erode.

GRAPHS TIME!

We need confirmation that this ship is slowly turning and to do this we should look at recent trends, are they making inroads into reducing debts, reducing costs or increasing revenues? Below are a few simple charts to look for the direction Vodafone could be heading.

From the above it does look like the trend is improving, admittedly this is only from September 2021 through September 2023 but total debt has reduced by around €4.5bn, not particularly significant but a reduction nonetheless. As a result of the largely flat current assets the net debt has dropped, again, albeit not significantly. Let’s look at income next.

OK, so I went back a bit further for the revenue and net income graph above and just used the annual statements rather than looking at any interim data, generally it’s pretty positive. The overall revenue has been pretty static over the last few years, which would normally be considered as not a positive but anyway… this includes the disposals mentioned previously so given the net income is increasing this should be an indication of increased profitability. Next, cash flow.

Well, I’d certainly say that based on the above graphs it appears that things have been improving. It is difficult to fathom what the result will be after Vodafone have shed all of the parts of the business they no longer see as a good fit. But you have to assume that by keeping the more profitable businesses and in combination with the planned reduction in overheads a leaner business will generate more cash. They are however in an increasingly competitive market and profit will be harder to come by.

COMPANY COMPARISON

I can’t help but think that a quick comparison could help, so I’m going to run some quick metrics for BT Group to see how they compare.

It’s not an ideal comparison really as all of the Vodafone outputs are based on them shifting large parts of their empire. However, they both have high yields and have a market value that is below that of their book value, this gives me the impression that this sector is likely not in favour and could mean that there is potential to find value. This would make sense and is why Vodafone is currently trying to merge with Three UK. Now in recent times both of these firms would have suffered with increased costs for energy, materials and staffing and I know they’ve been increasing prices to reflect this. I also know that except for personnel costs, most other costs impacting this sector (a big one being energy) are falling. I doubt they will be reducing many customer contracts in turn, increasing profits in the medium term.

Summary

Now, I certainly don’t expect Vodafone to grow their business in the near future, they’re already in the process of hiving off parts of the business that are less profitable and will likely use the proceeds to reduce debt levels and (probably for a while longer) continue to pay out a generous dividend although it may well be cut from its current level. The real issue here is whether Vodafone can turn things around and do so in a manner that will not continue to impact the share price, at present the dividend payment must be a headache for them as cutting this could reduce the share price but to continue paying it limits future prospects. They are also losing customers due to issues with customer service, I suspect they can fix this quite quickly with the right focus but they’re also going to need to be more competitive on pricing which again leads to reduced revenues and slower recoveries.

For what it’s worth I do think they will be able to recover and potentially in future grow profits but a lot of this could be reliant on them being allowed to merge with Three UK and the Competition and Markets Authority (CMA) has launched it’s initial 40-day investigation into this merger on the 2dn February. The problem for Vodafone is that they’re in a market where they cannot offer anything significantly better than their rivals and the only real variables are price and to a lesser extent performance, I say lesser extent because there isn’t very much in it these days between the network providers.

They have a relatively large pot of cash currently and although debt levels are high they are only slightly over three times cash levels which seems pretty manageable to me. They are due to provide a Q3 FY24 Trading Update tomorrow so I will be interested to see what comes of this and will make a decision then. As it stands I actually think I will increase my holding in Vodafone which surprises me as for the last year I’ve been thinking of selling.