Vodafone (LSE:VOD) shares have been tumbling in recent months, sending the dividend yield even higher. This company, once the largest on the FTSE 100 — hard to believe I know — currently trades for just 72p.
Despite this heavily discounted position — demonstrated by the chart below — I don’t believe it’s time to buy this stock just yet. Here’s why.
Transition, but what does it mean?
There’s lots going on at Vodafone. The telecoms giant recently announced that it plans to merge its UK operations with Three, a subsidiary of CK Hutchinson Holdings, the multinational conglomerate headquartered in Hong Kong.
Subject to Competition and Markets Authority approval, the group, which Vodafone would own 51%, will become the largest network in the UK. Broadly speaking, the merger should allow the companies to pool resources and benefit from economies of scale on the roll out of 5G and other innovations.
We can also see that Vodafone has been looking to simplify its operations. It recently sold its positions in Ghana and Hungary, and has plans to lay off 11,000 staff over the next 36 months. The cuts equal around a 10th of its global workforce.
It’s obviously positive to see management tackling the company’s challenges. However, buying a stock in transition is also challenging because we don’t know exactly what these changes will mean in terms of cash flows, debt, and a host of things going forward.
Am I making a mistake?
I actually bought Vodafone around six months ago. But I need the capital elsewhere, and I had grown a little unsure about the stock. So I sold and actually made 5%. In the end, I was fortunate as I’d be 20% down today if I had held.
Of course, I could be making another mistake here. But there’s no point making an investment if I’m not convinced. As billionaire super-investor Warren Buffett said: “With each investment you make, you should have the courage and the conviction to place at least 10% of your net worth in that stock.” I don’t have that conviction today, and the transition is just one part of that.
One concern is debt. Net debt is down 20% year on year. However, with interest rates rising — notably even more after Wednesday’s data — servicing that €33bn of debt could become more expensive.
Given the climate, I feel it’s also likely that the dividend will be cut this year. The dividend was only covered by earnings 1.3 times last year. New CEO Margherita Della Valle may have more leeway to cut the dividend without admitting strategic defeat — she only took over in January.
I don’t doubt that there’s plenty of opportunity here. We’re talking about a deeply discounted stock, one that’s down 40% over 12 months and trades with a price-to-earnings ratio of 7.45. But I’d see this as something of a speculative investment. Things could get worse.
