Vodafone has been one of the most popular stocks among UK fund managers and retail investors in recent years – 56 of the 96 funds in the IMA UK Equity Income sector currently hold it in their top-10.
Last September the company announced that the sale of its stake in Verizon Wireless would net shareholders 112p per share in a mixture of cash and Verizon shares. Shares are currently priced at 222.6p.
This means that a large number of investors will be left with a serious, but pleasant decision to make.
Assuming you haven’t earmarked the money for a new conservatory or a holiday, the question is where to invest it.
And with Vodafone being a much slimmed down company after the deal, should you hold onto the new company and even reinvest the dividend in that?
Michael Clark (pictured), manager of Fidelity MoneyBuilder Dividend, recently sold his stake in Vodafone.
He says that the sustainability of the stock’s dividend is less secure, mainly because the company faces a challenging operating environment in Europe. “Essentially, Vodafone has done a deal with its American counterpart and has sold its US business, and is now left with its European business,” Clark explained.
“Nearly every telecom company in Europe has had to cut its dividend and my concern with Vodafone is that it has thin dividend cover from free cash-flow. I think its cover is now too low, so I don’t recommend it as an income stock.”
The manager also thinks that the capital raised by the Verizon sale is likely to be diverted into acquisitions instead of given back to shareholders.
Helal Miah, analyst at The Share Centre, agrees. He says that he rated the stock as a buy before the announcement of the Verizon sale, but the new entity is rated a hold.
“The dividend is still going to be fairly good,” he said. “Where we are now in terms of yield is 4.5 per cent.”
Miah notes that the company’s cash-flow could suffer after the reorganisation of the stock.
“With Vodafone, the cash-flow has been pretty much supported for the past few years by the Verizon dividend it received; without that, the dividend cover won’t be as great as it has been in the past.”
The second reason the stock has come off the buy-list is that the sharp share price rises that followed the announcement represented a good opportunity to take profits, the analyst says.
Vodafone announced it was in advanced talks over a sale in September last year, and shares are up more than 20 per cent since then.
Performance of stock over 1yr
Source: FE Analytics
Like Clark, Miah also points out that the company’s withdrawal from the US leaves it more reliant on Europe, where results have painted an unflattering picture in recent years. Results for Spain and Italy have been disappointing, he says.
“It leads Vodafone to be more European- and emerging markets-focused, so less diversified,” he said.
“The attraction of Vodafone in the past was it always had US and European exposure.”
Vodafone is trying to shift more into emerging markets and Miah says that longer-term, this could be a good strategic move: smartphone penetration into those markets has been slower and could be a source of growth further down the line.
Miah says that there isn’t an alternative in the telecoms sector that would pass muster for investors looking to reinvest their dividends.
“On telecoms you are probably looking at yields of 3 to 3.5 per cent,” he said.
BT is currently yielding 2.89 per cent after a period of strong growth.
Richard Colwell, co-manager of the £2.48bn Threadneedle UK Equity Income fund, hasn’t held the stock in recent years, missing out on the benefits of the Verizon deal.
However, he has held BT throughout the period. While the yield on the stock isn’t as high, it has seen stronger growth in recent years, reaffirmed by recent strong demand for its fibre-optic broadband services.
Colwell notes that it has been a “score draw” between BT and Vodafone over the last year, although this may be too kind to the latter company.
Our data shows BT has appreciated 52.99 per cent in one year alone compared with Vodafone’s 37.16 per cent.
Performance of stocks over 1yr
Source: FE Analytics
Colwell says he remains unconvinced by Vodafone’s attractions after the deal.
“The fact they have indicated they need to invest more in capital expenditure in Europe indicates my concerns that the core cash-flow wasn’t as secure as people thought was correct,” he said.
The manager says that he continues to prefer BT in the sector, while he also highlights Shell as an opportunity.
He believes the company is undervalued and the new manager has been vocal in his desire to squeeze more money out of existing assets. Colwell says if he delivers on this, it should see better performance.
However, the manager’s views on energy stocks are at odds with those of a specialist management team FE Trustnet spoke to earlier this week.
Miah suggests that investors who wish to reinvest dividends should consider other sectors.
“We would be looking at similar companies with large balance sheets, low to medium risk, yielding 4.5 to 5 per cent,” he said.
He says GlaxoSmithKline, National Grid and United Utilities would all fit the bill.
The analyst also favours Royal Dutch Shell, even after its recent profit warning which saw shares take a 4 per cent hit. They are just over 1.5 per cent down since the figures were released.
Performance of stock over 1yr
Source: FE Analytics
“This is a company that will be paying a good dividend. They have been growing the dividend steadily over time.”
“The industry as a whole has had a bad time recently, but longer term we would expect it to do better,” he added.
“It has a good recovery ratio. It won’t generate huge capital growth, but if you are looking at it from an income perspective, it looks good.”
There has been bid talk around Vodafone, and AT&T has been forced to state it is not interested in buying the company at the current time.
It cannot return for six months due to stock exchange rules, but the possibility remains.
Fund managers caution against buying a stock solely on expectations of a takeover boosting the share price, however.
