Shares in Vodafone (LSE: VOD) have slipped back by 13% over the last three months. That’s a far worse performance than that of the FTSE 100, which is only down 3% over the same time period. The fall means that Vodafone now yields 5.9%, with the company now being one of the highest yielding stocks in the index and, as such, it has become a hugely attractive company to own within income-seeking portfolios.
However, could Vodafone’s dividend come under pressure from a cut? More importantly, is it really a super income stock to own?
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Dividends Exceed Earnings
Although Vodafone is being generous with dividend payments — they’ve increased by an average of 6.5% per annum over the last three years — it appears as though the company is actually being too generous. That’s because dividends per share currently exceed earnings per share, meaning Vodafone is paying out all of its net profit to shareholders each year in the form of a dividend, but is also paying out cash from its own account to further bolster shareholders’ income.
Indeed, the extent of this overpayment is fairly large. For instance, in the current financial year, Vodafone is forecast to deliver earnings per share (EPS) of 6.8p, and yet is expected to pay out 11.4p per share in dividends. Furthermore, the situation is expected to be similar next year, when Vodafone is set to grow EPS to 7.1p, but at the same time is due to increase dividends per share to 11.8p.
Unsustainable
Clearly, the current situation is unsustainable in the long run, but that shouldn’t worry shareholders. That’s the case for two main reasons.
Firstly, it appears as though the market has already priced in a dividend cut. Certainly, Vodafone is likely to remain a relatively high yielding stock, but its current yield of 5.9% appears to be excessive and is unlikely to remain so high in the long run.
Indeed, as has been the case with other FTSE 100 companies, such as RSA, in the recent past, the market prices in a dividend cut, which gives management the scope to effect one. Vodafone’s share price fall in recent months could be a sign of this taking place and, even if it does happen, the current level of earnings seems adequate to generate a yield that is still higher than that of the wider market.
Growth Potential
Secondly, Vodafone may not have particularly strong short term growth prospects, but its strategy appears to be very sound when it comes to long term growth. The company is buying up undervalued European assets and banking on a Eurozone recovery. This could work out very favourably for the company’s bottom line, so even if Vodafone’s current dividend payments are unsustainable, the company may be able to cope with them in the short run so long as its strategy comes through with growth in the longer term, which it seems set to.
So, while investors may be rightly concerned about the possibility of a cut in Vodafone’s dividend, it is likely to remain highly profitable in the long run and, crucially, can still afford an impressive dividend in the meantime. As a result, Vodafone remains an attractive income play.
