Right now, the Vodafone (LSE: VOD) share price supports a dividend yield of 5.3%, compared to the FTSE 100 average of 4.5%. At first glance, this looks attractive. But there’s much more to this telecommunications giant than its dividend yield. So today, I’m going to explore the pros and cons of investing in Vodafone at the current level.
Mixed outlook
It has been a bit of a rough year for the company. Back in May, after repeatedly saying it wouldn’t, the company cut its dividend by 40% to try and bolster its balance sheet.
Then, over the following months, City analysts slashed their growth forecasts as Vodafone’s outlook deteriorated. This time last year, analysts were expecting the group to earn €0.12 per share in net profit for fiscal 2020. They’re now expecting just €0.08 of income per share for the current financial year — that’s a significant drop.
Even more concerning is the company’s weak balance sheet. Following the €19bn acquisition of Liberty Global’s assets in Europe, Vodafone’s borrowings are on track to hit a staggering €55bn. Asset sales are in the pipeline to help pay down some of this towering obligation, but the level of borrowing makes me nervous.
Vodafone generated €13bn of cash from operations for fiscal 2019, implying it would take more than four years for the enterprise to pay off its debts entirely. This would be impossible, because the group would still have to fork out for spectrum rights, which are rising in cost. In Germany, for example, the company has had to pay out €1.7bn in spectrum rights alone.
Cash flow pressures
All of the above leads me to the conclusion that Vodafone’s dividend is on shaky ground. The company can afford it at the moment, but costs are rising. What’s more, if creditors start to demand higher rates of interest from the group — as compensation for taking on the risk of lending to a highly leveraged business — Vodafone might have to make some tough choices.
These could include cutting the dividend further, or reducing investment. The latter is likely to have a severe impact on the company’s ability to be able to attract and retain customers, so management is unlikely to take that route.
The bottom line
So overall, while Vodafone’s dividend does look attractive, compared to the FTSE 100 average, the company’s high level of borrowing puts me off the stock.
My research tells me there are many other companies out there that offer similar dividend yields but have much stronger balance sheets. In fact, there are 33 stocks in the FTSE 100 that current support dividend yields of 5.3% or more, and 10 of these have dividend cover of 1.5 times or higher.
By comparison, Vodafone’s dividend per share isn’t covered by the group’s earnings, which is a sure sign the payout is unsustainable.