Shareholders of Vodafone (LSE: VOD) were cheered by the company’s annual results this week, with the board lifting the dividend by 2% to 11.45p a share. The dividend is a big draw for investors, with a 5% yield on offer at a current share price of 228p. But can Vodafone afford it?
Cash flow is the lifeblood of dividends
On the face of it, things don’t look good. Earnings per share came in at just 5.04p, and won’t get close to covering the dividend any year soon. However, accounting earnings are one thing, but it’s cash flows that are the lifeblood of dividends. With Vodafone’s huge Project Spring investment programme now completed, how are cash flows shaping up?
The table below shows some select numbers that I’ll refer to in examining Vodafone’s cash flow and dividend prospects.
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| Financial year | Capex (£bn) | Free Cash Flow (£bn) |
Licence & spectrum costs (£bn) |
Restructuring costs (£bn) |
FCF after licence & spectrum and restructuring costs (£bn) |
Ordinary dividends (£bn) |
|---|---|---|---|---|---|---|
| 2012/13 | 5.3 | 5.7 | 2.5 | 0.3 | 2.9 | 4.8 |
| 2013/14 | 6.3 | 4.4 | 0.9 | 0.2 | 3.3 | 5.1 |
| 2014/15 | 9.2 | 1.1 | 0.4 | 0.3 | 0.4 | 2.9 |
| 2015/16 | 8.6 | 1.0 | 2.9 | 0.2 | (2.1) | 3.0 |
| 2016/17 | 6.8 (est.) | >3.2 | 1.5 (av.) | 0.25 (av.) | >1.4 | 3.1 (est.) |
The elevated capital expenditure in 2014/15 (£9.2bn) and 2015/16 (£8.6bn) reflects Vodafone’s Project Spring investment programme. Taken in isolation these numbers appear huge, but when we look at other years, we can see that Project Spring pretty much represents three years of normal capex squeezed into two. Massive annual investment is simply a fact of life in Vodafone’s industry.
Based on statements by the company, I calculate capex normalising to £6.8bn in 2016/17 — £1.8bn lower than the year just gone. This will help free cash flow (FCF) rise from £1bn to Vodafone’s explicit guidance of ‘at least’ £3.2bn. As you can see, this would cover the ordinary dividend payout, which I estimate will be £3.1bn — the first time FCF will have covered the dividend since 2012/13.
However, the FCF figure Vodafone gives is before M&A activity, licence & spectrum costs and restructuring costs. While M&A activity is certainly discretionary, I prefer to treat licence & spectrum and restructuring costs as annually recurring and necessary expenses. On this basis, FCF hasn’t covered the dividend in any of the last four years and won’t cover it in 2016/17, assuming the annual average of combined licence & spectrum and restructuring costs of £1.75bn.
A much more encouraging picture
If Vodafone’s guidance and my estimates are near the mark, Vodafone won’t be quite at the point this year where FCF (after licence & spectrum and restructuring costs) covers the dividend. However, with operating cash flows set to rise as the Project Spring investment comes through over the next few years, and £10.2bn of cash on the balance sheet for M&A activity, it’s not hard to see Vodafone moving quite rapidly to a position where the level of FCF means the company can ‘afford’ the dividend.
In summary, then, the cash-flow outlook paints a much more encouraging picture for the sustainability of Vodafone’s dividend than that presented by earnings forecasts. As such, I would say that the company’s 5% dividend yield appears attractive.
