Investors in FTSE 100 telecoms giant Vodafone Group (LSE: VOD) have needed to be quite trusting over the last few years. Chief executive Vittorio Colao has overseen a major programme of investment in the company’s assets and services, but shareholders haven’t really had much visibility of results.
There’s also been some anxiety about the group’s dividend, which hasn’t been covered by earnings since 2015. Would it be cut?
The good news is that Vodafone’s profits are now finally starting to rebound, making a cut less likely. Operating profit rose from €1.3bn to €3.7bn last year, despite a 4.4% fall in group revenue.
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Although the group still reported a hefty after-tax loss of €6bn, this situation is expected to improve this year. Full-year after-tax profit is expected to be €2.3bn. A further increase to €2.7bn is pencilled in for 2018/19.
Although this still isn’t enough to cover the €0.15 per share dividend, last year’s underlying free cash flow of €4.1bn was enough to cover the payout. Guidance for the current year is for underlying free cash flow of €5bn, which suggests to me that a dividend cut is unlikely.
Home and dry?
Despite this progress, I think there are still a few risks facing investors. The first is that the group’s sales fell by 4% last year and are expected to fall again this year. Falling sales mean that profit growth can only come from lower costs or higher consumer pricing.
Another risk is debt. Vodafone’s net debt rose to €31bn last year, equivalent to around 2.2 times earnings before interest, tax, depreciation and amortisation (EBITDA). Although this should be manageable, I’d not want to see it climb much higher.
The shares currently trade on a forecast P/E of 28, with a prospective yield of 6.1%. This odd rating suggests to me that the market trusts Vodafone’s dividend and expects earnings it to rebound. I suspect this view is correct, so I’d be willing to buy today.
An alternative choice?
Homewares retailer Dunelm Group (LSE: DNLM) has fallen by 32% over the last year. Although profits reached a record high of £102.3m in 2016, they’re expected to fall to just £88.3m this year.
Big retailers with falling sales are out of favour at the moment, and investors have steadily sold off the stock. The recent departure of chief executive John Browett hasn’t helped confidence either.
However, it’s worth remembering that this is an extremely profitable company, with a strong balance sheet. The group’s operating margin last year was 14.7%, which is significantly higher than most other big retailers. Although this figure fell to 12.4% during the first half of this year, there are signs of hope.
In its year-end trading update, Dunelm reported like-for-like sales growth of 1.3% during the 13 weeks to 1 July. Home delivery sales rose by 32.1%, giving a total like-for-like increase of 3.8% over the same period last year. Although profit margins remain under pressure, if this momentum can be maintained, then I think the stock could offer good value.
Net debt remains extremely low at just over £100m, and Dunelm has historically benefited from strong cash generation. With a forecast P/E of 14 and a well-covered yield of 4.1%, I believe these shares could be worth a closer look.
