One of the most hotly debated FTSE 100 dividends at the moment is the 9% yield on offer from telecoms giant Vodafone Group (LSE: VOD).
Is this payout affordable, or will it be cut? I’m bullish and recently bought some Vodafone shares for my own portfolio. Today I want to explain why I think Vodafone shares are a better bet for income than a cash ISA, even if the dividend is cut.
Shares vs cash
Cash ISAs should be a great way to save. But with best-buy interest rates currently sitting at less than 1.5%, the real value of your savings won’t even keep pace with inflation, which is 2.2%.
Although I believe keeping some savings in cash is essential, I think the stock market is a much better choice for investors who want to earn a decent return over long periods.
The FTSE 100 currently offers a dividend yield of 4.6%, so you don’t have to take the risk of buying individual stocks to enjoy a decent income. But if you are willing to accept a little extra risk in return for a higher income, I think Vodafone may be worth considering.
A clear opportunity
To understand the opportunity at Vodafone, we need to take a step back. Over the last decade, former chief executive Vittorio Colao reshaped the company through a series of major deals and network upgrades.
Mr Colao left last year and was replaced by the group’s chief financial officer, Nick Read. Mr Read’s first task was to bed down the changes made by his predecessor. That means stripping out costs and duplication, simplifying operations and building customer loyalty.
Since Mr Read took charge on 1 October, he’s said that he expects to be able to cut the group’s European operating costs by €1.2bn by 2021. He’s also considering whether to sell some of the firm’s network of radio towers. Barclays has previously valued the group’s European mast network at €12bn.
Why I’m backing the dividend
In my view, the plans outlined above should be enough to cut Vodafone’s debt and secure its dividend.
The group already generates plenty of cash. Mr Read’s current guidance is for free cash flow of €5.4bn for the year to 31 March. That’s already enough to cover the dividend, which I estimate costs about €4bn each year.
The only problem is that Vodafone is expected to need extra cash over the next few years to buy radio licences and equipment for its 5G network rollout. This pressure is one of the main reasons why some City analysts are forecasting a dividend cut.
What if the payout is cut?
In a worst-case scenario, I think we’d probably see a 50% dividend cut. That would give a payout of about 6.5p per share, down from c.13p currently. Investors would probably want a yield of at least 5%, which would push the share price down by about 20% to c.120p.
For buyers at the last-seen price of 142p, a dividend cut of this scale would give a yield of about 4.5%.
On the other hand, if Mr Read is successful, I could see the shares returning to the 200p-220p range seen in 2017. That would give a 50% profit from current levels, plus an ongoing 9% dividend yield.
In my view, the potential reward outweighs the risks. That’s why I rate Vodafone as a buy.
