Why Vodafone Group Plc Could Drop To 160p

We warned you about the perils of investing in Vodafone (LSE: VOD) (NASDAQ: VOD.US) when it recently traded at 258p a share. “It has become one of the riskiest stocks in the FTSE 100,” I argued on 2 June.  

Two weeks later its shares now trade at 231p, for a 10% capital loss over the period. You still have time to sell, and here’s why I think you’d be wise in doing so. 

Dividends

Vodafone announced a final dividend per share “of 7.62 pence, up 2.0%, giving total dividends per share of 11.22 pence,” for the year ended 31 March 2015.

Over the next twelve months, most analysts expect an annual dividend of 12p a share, which may be enough to draw the attention of some investors — not all investors, though. 

I am not interested in Vodafone and I am concerned you’d be paying too much for a mild rise in dividends, which are not covered by core cash flows.

Let’s look at its earnings profile, then. 

Earnings

Last year, basic earnings per share (EPS) came in at 21.75p, but adjusted EPS from continuing operations stood at 5.55p.

If this looks difficult to understand, well, it is not: as Vodafone says, adjusted EPS from continuing operations excludes the gain on disposal, results and related tax charge of the group’s former investment in Verizon Wireless in the prior year and the recognition of deferred tax assets in both years. 

The adjusted EPS figure is the one we need to keep in mind for comparison purposes, although the unadjusted projected EPS could be much higher than that in 2016. 

Vodafone At 120p-160p

Between 2009, when the stock market rally started, and the end of 2012, before takeover and break-up speculation began to emerge, Vodafone stock traded between 120p and 160p.

At the beginning of the period, adjusted EPS decreased by 6.2% to 16.11p for the year ended 31 March 2010, while basic EPS increased to 16.44p, primarily due to impairment losses and income tax credit. 

In 2011, adjusted EPS was 16.75 p, up 4.0% on the previous year, reflecting higher profitability and lower shares in issue following a £2.8bn buyback programme.

In 2012, adjusted EPS was 14.91p, down 11.0% over the prior year. 

Finally, one year before the divestment of Verizon Wireless, 2013 adjusted earnings per share was up 5.0% at 15.65p, driven by growth in adjusted operating income and a lower share count. 2014 figures told a similar story. 

Of course, Vodafone has entertained huge divestments and large acquisitions over the last few years, so its asset base has changed a lot, but now you’d be paying more — much more! — for a lower — much lower! — amount of earnings, and arguably higher dividend risk. 

While I appreciate that some investors may still have faith in Vodafone; its core services revenues are not growing, its capital structure is stretched, its assets base is poorly diversified and a hefty M&A premium is priced into its shares — all of which points to a fair value some 70p to 90p below its current valuation of 231p a share, in my opinion.