The FTSE 100 is home to many income stocks offering substantial dividend yields. In fact, 25 of its 100 constituents currently offer payouts over 5%. But Vodafone (LSE:VOD) is stealing the show with a payout at a whopping 10.8%!
Investors are seemingly looking at quite a chunky passive income opportunity. But this yield is only as good as the telecommunication company’s earnings. And if the latter can’t be sustained, then the income prospects will quickly evaporate.
Let’s take a closer look at why the dividend yield is so high and whether this is a buying opportunity, or an income trap.
A new chapter for Vodafone shares?
Shareholder payouts can reach impressive yields by one of two methods. Either management increases dividends, or the share price takes a tumble.
In the case of Vodafone, it’s currently the latter. The group’s 2022 results continued to show lacklustre returns with shrinking sales and underlying earnings. That’s certainly placed new CEO Margarita Della Valle in the hot seat.
After taking over in April this year, Valle has announced a new recovery plan to get the business back on track. She’s placed particular focus on Germany, which is currently the group’s largest source of income.
Despite the efforts of her predecessor, sales have been steadily falling along with earnings. And while the announcement of a new strategy is welcome, it’s a story investors have heard before.
So is Valle actually delivering? With only a few months under her belt, it’s too soon to tell. But there are some promising initial signs of progress.
German service revenue only shrunk by 1.3% versus 2.8% in this latest quarter. In the meantime, the company has signed a new deal with 1&1 Moblifunk to provide nationwide 5G coverage across the country as of the second half of 2024.
Can the dividend yield be sustained?
One of the biggest issues I have with Vodafone shares is its structural problems throughout the European markets. Deploying telecommunications infrastructure is exceptionally expensive, and costs have seemingly gotten out of hand.
Vodafone’s return on capital employed (ROCE) sits at just 6.8%. By comparison, the average industry cost of capital is around 9.9%, meaning that shareholder value has been getting wiped out for years – a trend that still hasn’t reversed.
To tackle this issue, Valle intends to trim 11,000 jobs across the board to reduce costs and improve margins. That’s roughly 10% of the firm’s workforce. And the savings will be reinvested to pay down debt as well as improve customer experience to increase retention.
This certainly sounds like it could work. But executing this strategy successfully isn’t going to be easy. And unintentionally eliminating critical workers from its talent pool could backfire, creating new headaches.
Should this worst-case scenario occur, the dividend yield could easily end up on the chopping block. As things stand, there is a great deal of uncertainty surrounding this enterprise. While I see a potential path to maintaining its current dividend payments, many things have to go right.
Personally, I’m not willing to take this risk and, therefore, I’m searching elsewhere for high-yield income opportunities.
