Investors searching for high dividends over the past year have flocked to income superstars Vodafone Group (LSE: VOD) and GlaxoSmithKline (LSE: GSK). However, with shares in each company now yielding over 5%, some City analysts are beginning to doubt the longevity of these high dividend payouts.
Two years after beginning a massive £7bn programme to upgrade infrastructure across its network, Vodafone is finally set to begin reaping the rewards of this investment. The company has focused on increasing 4G services to customers in Europe in order to lead customers to use more data and purchase larger data packages. 4G coverage has increased in these two years from 32% of Europe’s population to a full 80% and data usage increased 75% in the first half of 2015. With only 20% of European customers using 4G data plans, there’s also significant room to increase sales. Competition-beating data speeds will lock-in customers and allow Vodafone to continue raising margins over the long term.
Vodafone’s current dividend yield of 5.2% and net debt of £29bn has led some to question whether progressive dividend payouts are safe. However, with capex spending slowing down and earnings set to stabilise in 2016 and grow in 2017, dividend payments are covered for now. Vodafone’s massive investment in infrastructure should serve the company well for at least a decade as commercial 5G networks aren’t expected to be viable until at least 2020 and will take much longer to be adopted en masse. With safe dividends and growth potential, investors would do well to watch for a dip in share prices as the current forward P/E of 45 makes Vodafone quite expensive.
Clever strategy?
Pharmaceutical giant GlaxoSmithKline shares are currently yielding 5.85% with an increase to 6.2% expected for the next year after a £1bn special dividend is announced next month. Furthermore, dividends should remain safe as they’re currently covered 1.24 times by earnings. GSK’s management is charting a different path to growth than many pharma competitors as it focuses less on high-cost specialty medicines and more on high-volume affordable drugs as a play on increased healthcare spending in developing markets. As developed countries increasingly search for healthcare savings this may prove to be a prescient move.
Shares are currently priced at 16 times 2016 earnings with EPS forecast to grow by 11% this year. While increasing reliance on consumer healthcare products brings margins in the 13% range rather than the 70% range found in GSK’s HIV medicines, it also means less money spent on costly acquisitions and less lumpy revenue streams. With GSK’s debt-heavy balance sheet this strategy seems very wise as the company lacks the financial firepower necessary to keep up with nimbler opponents such as Astra Zeneca and Shire. With strong positive cash flow year after year, a reasonable valuation and return to growth earmarked for this year, I see a defensive share such as GSK as a definite addition to watch lists for long-term investors.