Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) is a firm that I rate highly, but when I took a closer look at the mobile giant’s latest results, I noticed that the mobile giant uses an accounting trick which makes it harder for investors to keep track of Vodafone’s true cash profits.
Adjusted reality
One the key metrics Vodafone always highlights in its results is free cash flow. This is usually defined as the operating cash flow that is left over after tax, interest and capital expenditure have been deducted. It’s genuine surplus cash, so strong free cash flow should mean a low-risk dividend.
The only problem is that Vodafone doesn’t use this standard definition of free cash flow in its results, which could easily confuse investors wanting to check the safety of Vodafone’s dividend.
£5.6bn or £1.6bn?
Vodafone calculates its published free cash flow on an adjusted basis, and the differences can be quite surprising. For example, in its 2013 results, Vodafone reported free cash flow of £5.6bn, which sounds impressive, and was enough to cover the £4.8bn Vodafone paid out in dividends last year.
The only problem is that Vodafone excluded the following items from its free cash flow calculation in 2013: licence and spectrum payments, payments in respect of a tax case settlement, and the income dividend received from Verizon Wireless in December 2012.
Vodafone’s share of the profits from its joint venture companies, such as Verizon Wireless, is also represented as actual income in its adjusted figures, even though in many cases the firm only receives dividends from these shares.
When I calculated Vodafone’s statutory free cash flow from its cash flow statement, I found that it came to just £1.6bn — a whopping £4bn less than the company’s headline figure of £5.6bn.
To be fair, the effects of adjustment can go both ways; in Vodafone’s half-yearly results, which were published in November, it highlights free cash flow of £2.0bn. Yet my calculations showed free cash flow of £4.4bn for the first half — more than double the adjusted figure.
Are adjusted results useful?
Although adjusted earnings can be useful, and are standard practice, I’m less convinced by Vodafone’s use of adjusted free cash flow. Free cash flow is meant to be a measure of the surplus cash generated by a business each year. Adjusting it makes it meaningless, in my view, as well as potentially misleading.