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Questor: Vodafone’s 9pc yield – too good to be true?
Questor share tip: the telecoms group faces multiple challenges and cover for the dividend looks thin
Telecommunications giant Vodafone is due to publish a trading statement on Friday. Its shares have been weak in the weeks preceding the statement, so they could always bounce after it, but fundamentally the company continues to give out the wrong signals.
The new boss, Nick Read, has already indicated that Vodafone’s two-decade-long streak of increases in its annual dividend will end in 2018 with an unchanged distribution of €0.1507. That is enough for a 9pc yield, but investors must be careful.
Granted, operating free cash flow (operating profit adjusted for depreciation and amortisation, tax, net working capital and capital investment) came to €4.8bn (£4.2bn) in 2017, enough to cover the €3.9bn cost of the dividend – but only by 1.2 times, which offers little margin of safety if anything goes wrong.
And Vodafone faces challenges on many fronts. Auctions to buy spectrum for fifth-generation (5G) mobile services are draining its coffers and spending on network equipment will start to rise. In addition, the core mobile telecoms operations face fierce competition in Britain, Spain and Italy, three of Vodafone’s four biggest markets.
The other one is Germany, and trading could be about to get tougher there too. The 5G spectrum auction begins there this month and the rules appear to favour the prospect of a new entrant to the market, which could raise the prices paid for spectrum and then put pressure on the tariffs that operators can charge their customers.
Read has already complained about European governments using the 5G auctions as a source of cash, surely an acknowledgement of the squeeze that Vodafone faces – pressure on profits and cash on one side, and rising outlays on the other.
It seems unlikely that the firm will cave in now and cut its dividend for 2019 but the pressure could only build from here – especially as 2018’s €18bn acquisition of the bulk of Liberty Global’s European cable TV operations has yet to prove itself. This may yet be one meaty-looking FTSE 100 dividend yield that proves to be too good to be true over time.
The shares have fallen by 26.7pc since this column first cautioned on them in February last year and investors should continue to steer clear. Avoid.
Update: Pearson
Our long-held aversion to Pearson left us looking rather silly last year as the educational publisher was the best performer in the FTSE 100, at least among those stocks that had been part of the index for the whole of 2018.
However, those gains leave the stock looking potentially overbought on nearly 16 times forecast earnings and a yield of 2.2pc – the former a premium to the FTSE 100 and the latter a discount – especially as last week’s trading statement left all of our concerns unanswered.
While 2018 profits are expected to be bang in the middle of previous guidance, this is due to higher-than-expected cost cuts. Boss John Fallon’s earnings per share forecasts for 2019 also met analysts’ forecasts but rest heavily on increased efficiency targets as US educational revenues remain weak. The quantity of profit may be there but the quality is questionable.
“Open Education Resources”, whereby universities make best-of-breed lecturing and educational materials freely available so that other students and lecturers can copy, use, append and even modify the documents and avoid the expense of buying or renting the sort of textbooks provided by Pearson, clearly remain a strategic threat.
Pearson still has questions to answer, and again this column is content to steer clear. Avoid.
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Update: Provident Financial 7pc 2020 bond
A profits warning hammered the shares of Provident Financial, the doorstep lender, last week. But the company’s rights issue last year gave holders of the 7pc bond that matures in April 2020 plenty of protection and its price barely flinched.
Income seekers can continue to calmly farm the 700p annual coupon, paid in April and October, until redemption next year. Hold.
- Questor archive: telegraph.co.uk/questor