The Vodafone (LSE: VOD) share valuation has often puzzled me. For years it looked overheated. But that has rectified itself a bit in recent years, with what I’ve seen as a much-needed correction. With the Vodafone share price down close to 45% over five years, we’re now looking at a trailing P/E of around 17. I’ve been starting to see that as attractive value.
Vodafone’s dividend policy has also had me perplexed. Paying big dividends, nowhere near covered by earnings, while building up debt? That looks like effectively borrowing money to hand to shareholders. I do like hefty dividend yields, but in my book, Vodafone’s approach was a big no. Dividends were cut back in 2019, which was a step in the right direction. But they were still not covered by earnings.
Vodafone share price drop
We had figures for the year to March 2021 on Monday, and the Vodafone share price took a tumble in response. At the end of the day, the shares were down 9%. It seems to be because the results came in a little below forecasts. The dividend was maintained as hoped, providing a 6% yield on Monday’s closing price. So, as a dividend chaser, does this provide an extra special opportunity for me to buy now?
My Motley Fool colleague Roland Head has taken a look at the numbers, and he’s pointed out that EBITDA was only 1% below market forecasts. Roland reckons that’s nothing to worry about, and I agree. If just a 1% miss can trigger a 9% Vodafone share price fall, I’d say stock markets are looking a bit twitchy right now. But I’m more interested in current dividend cover, and the company’s ability to keep paying out the cash over the long term. And what I see still troubles me.
Future dividend policy
Vodafone announced a dividend of 9 euro cents per share. But adjusted earnings per share came in at only 8.08 cents. So, once again, the company is handing out money that’s not coming from earnings. In my investments, I generally like to see minimum dividend cover of between 1.5x and 2x, depending on the nature of the company. Not 0.9x, especially from a company that has big debts and needs cash to invest to grow. Does some doubt about the future of dividends lie behind the Vodafone share price drop on the day? I think it could.
But what did Vodafone say about it? CEO Nick Read said “We remain fully focused on driving shareholder returns through deleveraging, improving our return on capital, and a firm commitment to our dividend.” So it doesn’t sound like there are any plans to reduce the payments. The company added that, as a medium-term ambition, it aims to provide a “minimum dividend of 9 euro cents per share per annum.”
Dividend cover is all I want
There was no talk of a progressive dividend policy. But until Vodafone grows its earnings enough to at least provide cover, I think that’s wise. So do I want to buy at the current Vodafone share price? Vodafone suggests it should see mid-single digit earnings growth in the medium term. And if it manages that, the dividend might be sustainable. But I’ll still wait until I see a clear prospect of improving dividend cover.