Is Vodafone (LSE: VOD) a sleeping giant? Or might it be a value trap? It seems many investors are not sure, given how the Vodafone share price has been moving around. It is 16% lower than a year ago and now trades in pennies not pounds.
I have been weighing up whether this might be an attractive buying opportunity for my portfolio.
Poor signals
The company published its interim results this week. Compared to the same period last year, revenue grew 2% and operating profit was up by 12%. Basic earnings per share grew by 4%, which I think is a solid performance.
But beneath the operating level, the company’s finances concern me somewhat – especially its balance sheet. Net debt was already a hefty €44.3bn at this point last year. It has now increased to €45.5bn.
At a time of rising interest rates, I would want to see debt falling not growing. Financing costs help explain why Vodafone’s operating profit does not translate into hard cash. The operating profit in the six months under consideration was €2.9bn and cash inflows from operating activities were an impressive €6.3bn. Yet there was an adjusted free cash outflow of over half a billion pounds.
In other words, Vodafone’s operations are profitable and throwing off lots of cash. But that is getting eaten up – and more – by calls on the company’s cash like debt costs and paying the dividend. One solution to that imbalance could be cutting the firm’s dividend, which it has done in the past. This time it held the interim payout steady, but that is no guarantee of what will happen in future.
Long-term outlook
Given my concerns about the dividend, why would I be willing to invest in this company?
I am a long-term investor. Vodafone has the makings of a profitable and highly cash generative business. It has several hundred million customers spread across a range of countries, including high-growth African markets. It also has a high level of brand recognition. That could help it retain customers if it utilises it in the right way.
Demand for data services is set to keep growing. That trend could boost revenues at Vodafone thanks to its already sizeable mobile data and broadband operations.
The costs and effort of setting up and maintaining a mobile network act as a barrier to entry. I therefore see an established player such as Vodafone as benefitting from a strong position in a growing market.
If the company can get to grips with its large and growing debt, I think its solid business performance could translate into healthier financial results.
The Vodafone share price looks cheap
Even if it decides to halve its dividend, the Vodafone yield would still be higher than many FTSE 100 peers.
I do not think the company needs to cut its dividend — but I do see it as a risk. I think that risk helps explain why the Vodafone share price has fallen to pennies. I see that as cheap for a company with Vodafone’s strengths. That is why, if I had spare cash, I would buy Vodafone shares for my portfolio.
