Please ensure Javascript is enabled for purposes of website accessibility

Vodafone Group: Income Stock or Value Play?

By Tony Reading - Jun 20, 2013 at 11:51AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The investment thesis for Vodafone Group has changed.

LONDON -- Vodafone (VOD 0.30%) (VOD 0.54%) is a popular stock with income investors, but some shareholders have become concerned at the increasing fragility of its cash flow.

Free cash flow
It's worse than you think. Analysts look at free cash flow -- operating cash flows less capital expenditure -- to assess a company's ability to keep funding its dividend. But the free cash flow figure that Vodafone reports is an idiosyncratic measure including income from associates it doesn't control, mainly U.S. joint-venture Verizon Wireless, but excluding license and spectrum payments it's obliged to make. Reverse those items and the picture looks like this:





Vodafone's own free cash flow




Income from associates




Dividends paid




Numbers in billions of pounds. *Excludes 2 billion pound special dividend.

Newbury, we have a problem. The cash from operations controlled by Vodafone falls woefully short of supporting the dividend. No wonder income investors such as Invesco Perpetual's Neil Woodford have bailed out.

Vodafone's Southern European businesses are suffering from deep recession, while the firm has strategic weaknesses as consumers devour more data and incline toward services that bundle mobile with Internet and TV. Vodafone CEO Vittorio Colao sees a fix in buying European cable operators like Kabel Deutschland and Fastweb, but a bidding war for Kabel could be expensive. It's a shame Vodafone doesn't have a better track record in acquisitions.

One purchase has proved a spectacular success. Verizon Wireless' majority shareholder has reportedly offered $100 billion to buy out Vodafone's 45% interest, and some analysts have put a figure of $130 billion or more on the stake. It's impossible to value Vodafone without taking into account VZW's value, which is in Vodafone's books at just $38 billion.

$100 billion equates to about 130 pence per share. $130 billion would be 170 pence. Estimates of the tax on a sale have varied wildly, but it's fair to assume the company would net something in this range if a deal were struck.

That begs the question, what is Vodafone's value without VZW? Despite a history of big impairment charges, it's reasonable to start with its adjusted EPS. My back-of-an-envelope calculation, assuming a 20% tax rate on dividends Vodafone receives from associates, splits adjusted earnings thus:





Adjusted EPS




Less: EPS due to associates




Vodafone's own EPS




All figures in pence.

Applying Vodafone's 11.5 projected P/E ratio to earnings of 5.1 pence suggests a value excluding VZW of around 60 pence, or 80 pence if you take the 7 pence three-year average EPS. Adding 130 pence to 170 pence for the VZW stake values Vodafone in the range of 190 pence to 250 pence, compared to its current market price of 185 pence.

A different person on a different day would come up with different figures, but the message is clear: Vodafone may no longer be a reliable income stock, but it could be a value play.

For a safer source of dividend income, I suggest you look at The Motley Fool's choice for this year's top income stock. That's a company yielding well over 5% in a sector that has good visibility of earnings, with a policy of increasing dividends by at least the rate of inflation. You can download the analysis by clicking here -- it's free.

Fool contributor Tony Reading owns shares of Vodafone. The Motley Fool recommends Vodafone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Vodafone Group Plc Stock Quote
Vodafone Group Plc
$14.84 (0.54%) $0.08
Vodafone Group Plc Stock Quote
Vodafone Group Plc
$121.58 (0.30%) $0.36

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/13/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.