Why the Weakness in Vodafone Looks Like a Buying Opportunity for Long-Term Investors

March 13, 2019 by Jon C. Ogg

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There are currently, and have been in the recent past, telecom and communication services stocks that offer incredibly high dividend yields. The problem here in analyzing dividends is that some communications and telecom companies have very creative methods of coming up with the cash to pay such high yields. Traditional telecoms are generally expected to have enough earnings and cash flow to keep funding their existing dividends.

One such company, at least for now, is Vodafone Group PLC (NASDAQ: VOD). It is indicated to have a yield of better than 9% based on existing share prices and expectations, at least that’s the view of the independent research firm Argus. While this blows away the 6.8% yield of AT&T Inc. (NYSE: T) and 4.3% of Verizon Communications Inc. (NYSE: VZ), and while there may be some issues with the dividend ahead, Argus has told clients in a fresh report that the recent trading weakness is offering an opportunity for long-term investors to get into the stock.

Vodafone is no longer tied into Verizon (wireless) like it had been in the past, and while it has more than 500 million mobile customers and 20 million fixed broadband customers, it is located in the United Kingdom. Vodafone also operates in Europe, Africa, the Middle East and the Asia-Pacific region. The market capitalization of its American depositary shares (ADSs) is almost $51 billion — less than one-fourth of the $238 billion of Verizon and $221 billion of AT&T. The U.S.-based AT&T and Verizon also appear to be more appropriate dividends for retirees to supplement their income, despite Vodafone’s higher yield.

According to the logic behind the Argus opinion that recent weakness is offering a favorable entry point, Vodafone ADSs have underperformed over the past three months and were hitting 52-week lows even in January. The ADSs ended 2018 at $19.28, and even after a small gain on Wednesday the shares were at $18.40. Vodafone has a 52-week range of $17.05 to $30.20 and a consensus target price of $26.17.

Before thinking this independent research call is an all-clear sign without any risks, it is important to consider that other firms do not universally share the same optimism in Vodafone. BNP Paribas downgraded its shares overseas on March 8 to Neutral from Outperform, and in February 2006 Vodafone took a corporate credit rating downgrade from Moody’s. Merrill Lynch also raised its rating to Buy in early February.

Argus cited that Vodafone pays an attractive dividend yield of 9.5%, but it does point out that even if the dividend is being maintained at this level that it is not entirely supported by earnings at this time. And Argus further noted that the dividend could be at risk if business trends don’t improve. Argus even lowered its target to $21 from $25 on the New York-listed shares. Fiscal year 2019 earnings are now projected by Argus at $1.00 per ADS, down from $1.25 previously and well below last year’s comparable $1.30 per ADS.

So why did the independent research firm remain so positive if it believes there is some risk to the dividend and if the price target was lowered? According to Wednesday’s research report:

Over the last five years, the company has transformed itself from a pure-play mobile operator to one offering a broad mix of communications services, including fixed broadband, video content, cloud and website hosting. It also recently completed a two-year capital investment program, which has significantly expanded its offerings and strengthened the capability of its network. We expect these efforts to boost earnings over time as the company monetizes its rising data traffic and growing customer base. Recent results have been affected by increased competition in Continental Europe. The balance sheet is solid, though, and the dividend yields 9.5% — though we would feel more comfortable if earnings covered the payout. For long-term, income-oriented investors, we think that VOD shares are suitable holdings in a diversified portfolio. Looking ahead, we think the rising interest rate environment may limit multiple expansion.

The most recent guidance on earnings from Vodafone showed only a 0.1% organic growth in its group service revenues to €10.2 billion. There was an improvement in Italy and steady results in the United Kingdom and Spain. There were also a decline in South Africa and a slowdown in Germany.

According to Argus, management is keeping a close eye on costs with a focus on procurement, sales channel efficiencies and standardized network designs. An additional benefit is that Vodafone also is looking at ways to monetize assets, including its towers.

On the dividend policy, Argus noted this:

Like most UK companies, Vodafone pays an interim dividend and a year-end dividend. The interim dividend is typically one-third of the full payout. For all of FY18, the company paid a total dividend of 0.1507 euros per share, which management has said it will maintain in FY19. Management has a “progressive” dividend policy, with a goal of modest growth once financial leverage has been reduced toward the low end of management’ target net debt/EBITDA range of 2.5-3.0. Our dividend forecasts are 0.1507 euros for FY19 and FY20. Based on the ratio of one ADR to 10 ordinary shares, our U.S. dollar dividend estimates are $1.72 for both FY19 and FY20. The current indicated yield is approximately 9.5%.

Vodafone’s shares are considered “attractively valued at current prices near $18.00” and are trading near the lower end of their 52-week range. Argus does point out that its technical pattern has been in a bearish pattern of lower highs and lower lows that dates to January 2018 and that the next level of resistance is $18.50 per ADS.

Vodafone’s ADSs closed up 1.4% at $18.42 on Wednesday.

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