Telecoms giant Vodafone Group (LSE: VOD) and pharmaceutical firm BTG (LSE: BTG) both have impressive forward projections for earnings growth. But do their rich valuations make the firms riskier than a defensive such as electricity and gas utility National Grid (LSE: NG)?
Capital investments paying off
At today’s share price of 226p, Vodafone’s price-to-earnings (P/E) ratio is high at around 29 for year to March 2018. However, the company has potential to grow into its valuation. Earnings are rising fast with City analysts predicting a 22% uplift in earnings per share this year, 29% next year and an upsurge in free cash flow that could soon be sufficient to cover Vodafone’s generous dividend payments.
2015 ended well for the firm. The three months to December delivered a strong performance in South Africa and improving trends in Germany and Italy. Vodafone reckons its investments in 4G and fibre networks in Europe are stimulating strong growth in data usage and the company welcomed 7m new customers in the final quarter of 2015.
Costs look set to remain static even as Vodafone harvests the growth opportunities that the firm is confident lie ahead, despite facing “regulatory and competitive challenges in many markets.” Earnings and cash flow need to improve in order to cover Vodafone’s dividend payments. The forward dividend yield runs at just over 5% for 2018 but earnings only cover the payout around 0.67 times.
Vodafone is building value but the share price remains ahead of events in my view. As such, an investment in the firm now does seem quite risky.
Growing well
BTG doesn’t have issues about its dividend cover because the firm doesn’t pay a dividend. However, the fast-growing pharmaceutical firm is attractive for forward growth prospects.
City analysts following BTG expect earnings to expand by 17% during year to march 2017 and by 25% the year after that. If the company’s new treatment for varicose veins, Varithena, takes off in the US as hoped, earnings could grow in double-digits for years to come. The rollout is slower than many bargained for because of delays with the process of achieving insurance coverage for the treatment.
Varithena looks set to do well in the end and BTG’s other treatments are growing too. Today’s 603p share price puts the firm on a forward P/E rating of just under 22, which seems like a fair price for the growth prospects on offer.
Earnings flat
Growth in earnings looks set to trail off at National Grid — a 2% uplift for year to March 2017 and flat the year after that according to City analysts following the firm. The gas and electricity transmission system operator enjoys a monopoly position in the energy market but that comes at the cost of high regulation, which keeps the firm ploughing much of its cash flow into maintaining its assets.
At today’s 972p share price, National Grid trades on a forward P/E ratio of just over 15 for year to March 2018 and pays a dividend yielding 4.7%. That seems high to me because there’s little growth on offer and the firm carries a large debt pile just like other utilities. Cash flows must service the debt and equity dividends, which can be a fine balance that an operational setback could easily upset.
To me, there’s just as much risk in National Grid’s valuation as there is in Vodafone’s and BTG’s. Given the choice, I would rather go with a firm with a clear path to growth and my preference here is BTG.
