Earlier this year, I sold my shares in Vodafone (LSE: VOD). Since then, the share price has continued to fall. The shares have lost 14% so far in 2023. That has pushed up the Vodafone dividend yield, however. It now stands at 10.5%. For a FTSE 100 share that looks unusually high.
Could a cut be on the cards – and might Vodafone still be a rewarding investment even if the payout is reduced?
Dividend sustainability
A common investing mistake is to focus too much on today’s yield rather than the future possible yield.
Should you invest £1,000 in Centrica right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Centrica made the list?
A 10.5% annual yield looks great to me. Vodafone could cut its dividend by 40%, as it did in 2019, and still yield what I see as an attractive 6.3%. Then again, it could take an axe to its dividend completely just like Direct Line did this year.
In the short term, a dividend can be paid even if a company is loss-making or has negative free cash flow, for example by dipping into reserves. Longer term, though, if a company’s free cash flow does not cover its dividend, it is hard to sustain it.
Vodafone dividend cover
Last year, Vodafone’s dividend was covered around 1.3 times by earnings. It has not been consistently covered by earnings in the past five years, though.
What about free cash flow?
Last year, the company had net cash inflows of €1.5bn even after spending €2.4bn on equity dividends (it also paid dividends to shareholders in certain subsidiaries). But that was just one of two years in the past five when Vodafone has generated positive free cash flow after equity dividends are taken into account.
Strategic choices
On one hand, maintaining dividends could become harder, let alone raising them. With interest rates rising, servicing the company’s net debt of €33bn could become more expensive.
A new chief executive arguably has more leeway to cut the dividend without it being seen as an admission of strategic defeat, though I think the best time to do that would have been last month’s results when the payout was in fact held flat.
Then again, it could be that a revamped strategy could boost free cash flows and so mean that the FTSE 100 share’s double-digit yield is here to stay.
Vodafone is making its biggest ever job cuts, which could help reduce its cost base. A plan to merge its UK operations with those of CK Hutchison’s 3 could improve profit margins.
Although net debt remains high, the full-year results showed it had fallen by around 20% in a year. Further asset sales could help debt reduction. That could make the investment case for Vodafone more attractive.
Buy or wait?
On balance, then, I am becoming more optimistic about the outlook for Vodafone than I have been recently.
If the business is turning a corner – as it may be – the current 10%+ Vodafone dividend yield might be here to stay.
If business goes well, though, I expect the share price to move back up. So the time for me to act might be now.
But Vodafone has disappointed investors in the past. So before buying, I would like to see more evidence of a sustained business recovery, even if it means waiting a few months to buy. For now, I will wait and watch.
