Why Neil Woodford Sold Vodafone

LONDON -- Ace City investor Neil Woodford, who manages more than £20 billion of investors' money, has thrashed the market over the last five, 10 and 15 years. And he has done it again this year.

The master investor's Edinburgh Investment Trust has just announced its annual results. The fund delivered a 20.1% return for shareholders over its latest financial year, compared with a 16.8% gain by the FTSE All-Share index.

Woodford told us that while the market as a whole is no longer as cheap as it was, "some high quality, dependable growth companies remain significantly undervalued." He added that he remains convinced by "their potential to deliver attractive positive returns over the medium/long term, regardless of the economic headwinds we expect to prevail."

Blue chip Imperial Tobacco (LSE: IMT  ) (NASDAQOTH: ITYBY  ) and midcap defense firm Chemring (LSE: CHG  ) are two companies in which Woodford sees significant value. I'll tell you what he has to say about them in a minute.

But first, let me tell you about Woodford's negative view of Vodafone (LSE: VOD  ) (NASDAQ: VOD  ) .

Vodafone
Vodafone remains a favorite of income investors, but Woodford is never afraid to go against the crowd. During the year, he made the bold decision to sell the trust's entire holding in the telecommunications giant.

While Woodford sold well above the year's lows for the shares, the market has since gotten excited about the possibility of a bid for Vodafone's 45% stake in U.S. joint venture Verizon Wireless. Numbers of $100 billion or more are being bandied about, and the shares have recently been changing hands at a 52-week high of about 200 pence.

The bid speculation aside, Woodford's sale of Vodafone was based on two factors: "Reservations about the company's ability to generate profits from data services" and a fall in the cash flow cover of the dividend to what he views as "uncomfortably low levels." (If you'd like to know more about the cash flow cover of the dividend, I looked at it in this recent article.)

Imperial Tobacco
Imperial Tobacco's shares fell during the year thanks to a challenging trading environment in southern Europe and worries that the U.K. will follow Australia's lead by introducing plain packaging for cigarettes.

However, Woodford believes that "the low valuation of the shares of Imperial Tobacco compared with its peers more than discounts these concerns and that the tobacco sector as a whole continues to offer attractive and dependable growth opportunities."

At a current share price of 2,375 pence, Imperial Tobacco is trading on 10.8 times 12-month forecast earnings, compared with 15.5 times earnings for British American Tobacco. At the same time, Imperial Tobacco offers a prospective dividend yield a full percentage point higher than its rival -- 5.2% versus 4.2%.

Chemring
Woodford has been a stalwart supporter of FTSE 250 defense group Chemring. The company has been through the mill over the past couple of years, dealing with a series of profit warnings, a potential bid for the firm that ultimately came to nothing, and a boardroom clear-out.

Chemring's businesses include equipment to counter improvised explosive devices, munitions, and defense pyrotechnics. Woodford is "confident" that with the new management team now in place, "long-term value can be realized from the high quality businesses within the company."

At a share price of 281 pence, Chemring is trading on a modest 10 times 12-month forecast earnings and a decent 3.5% dividend yield.

Dividend winners
Woodford excels at finding big dividend-paying winners for his market-beating funds, and we have a free Motley Fool special report for you, newly updated for 2013. You can download this free report right now -- and enjoy reading an exclusive analysis of eight of Woodford's favorite blue chips. Simply click here.


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