Telecom stocks such as AT&T (T) and Verizon (VZ) often serve as core holdings for income investors who have a low tolerance for risk, especially retirees living off dividends.
That makes sense because many telecom companies enjoy large, recurring streams of cash flow that support generous and slowly growing dividend payouts over time.
However, not all telecom giants make for good dividend investments. The industry is increasingly battling slow growth and increased competitive pressures, and some firms are better positioned than others.
Let’s take a closer look at Vodafone Group (VOD), one of the world’s largest telecom behemoths, to see if its 5.7% dividend yield is safe and appealing for our Conservative Retirees dividend portfolio, or if the company could be a value trap.
Vodafone was founded in 1984 in the U.K. and has quickly grown into one of the world’s largest telecom conglomerates.
Along with its joint venture partners, the company offers telephone, internet, cable TV, and wireless mobile services in 75 countries on six continents. In total, Vodafone serves 470 million mobile customers, 14 million fixed broadband customers, and 9.8 million TV customers.
While Vodafone’s global diversification is impressive, the vast majority of its business remains dominated by Europe, especially Germany (22% of EBITDA), Italy (13%), the U.K. (11%), and Spain (8%).
|Region||Q3 2016 Revenue (Euros)||% of Revenue|
|Africa, Middle East, Asia, Pacific||4.484 billion||32.7%|
Source: Vodafone Earnings Release
The company’s long-term plan calls for continued diversification into emerging markets, especially India, but management’s strategy is far from guaranteed to succeed.
At first glance, Vodafone’s been struggling with sales, earnings, and free cash flow growth that has been not just lackluster for years, but also very volatile. However, that’s largely due to “Project Spring,” management’s major three-year restructuring plan which it launched in 2013.
Project Spring included some major asset sales, including Vodafone’s 2014 sale of its 45% stake in Verizon Wireless for $130 billion (mostly used for a special dividend, taxes, and debt reduction), as well as a $9 billion increase in capital spending as the company invested massively into expanding and improving its European 4G LTE network.
In addition, Vodafone went on a major acquisition spree including:
- Germany’s Kabel Deutschland
- Dutch Wireless company Ziggo
- U.K.’s Cable & Wireless Worldwide
- Spain’s Ono
- Merger of its Vodafone India with Idea Cellular
Vodafone’s M&A spree was driven by the company’s positioning as pretty much a pure play wireless company, and one with very little exposure to 4G.
In fact, in mid-2014, Vodafone had only 4.7 million 4G customers in Europe and was losing market share quickly. However, Vodafone now offers a full suite of telecom services, including landlines, cable TV, internet, and far improved wireless services.
Meanwhile, the firm’s $23 billion merger with Idea Cellular will now create the largest wireless provider in India, with almost 400 million customers.
Idea’s strong spectrum coverage in rural areas will complement Vodafone’s India’s excellent coverage in urban areas and create a potentially dominant wireless network across the entire country.
Better yet? After the merger is complete Vodafone’s market share in 21 of 22 regions in the country (what it calls “circles”) should be #1 or #2. And the meaningful cost synergies (annual savings of $2.1 billion within four years) should help Vodafone become profitable in nearly all of India’s circles, compared to just 12 of 22 pre-merger.
In other words, Vodafone is hinging much of its growth hopes on India, which seems likely to remain one of the fastest growing economies and a large telecom growth opportunity in the coming decades.
That being said, Vodafone’s management still has a lot to prove because while the growth opportunities in India are enormous, Vodafone is only a majority partner in the combined company.
That means that Vodafone will need to de-consolidate its India business, which will make short-term growth harder. In fact, analysts expect Vodafone’s 2017 and 2018 fiscal revenues to decline by 3.5%, and 12.5%, respectively, before finally returning to growth starting in 2019 as the India business develops.
However, even after 2019, revenues are only expected to grow at around 2% per year because Vodafone’s European operations are likely to continue to struggle with slower economic growth and highly mature markets.
However, shareholders can likely look forward to stronger earnings and free cash flow growth because the company’s future capital spending is set to decrease substantially.
That should be good news for dividend lovers, although there are numerous risks that could plague the company and threaten its dividend.
The first risk that Vodafone shareholders will have to contend with is a large degree of currency risk. After all, Vodafone’s primary businesses obtain revenue in British Pounds, Euros, and Indian Rupees.
And U.S. investors get paid dividends in dollars, which means that the vagaries of currency exchange rates between these four currencies will only add to the volatility of Vodafone’s reported revenue, EPS, FCF, and dividend growth in the coming years.
Another major risk to consider is that, while Vodafone’s India business is now the largest in the country, the wireless market there remains highly competitive. In fact, even with 395 million total customers, Vodafone India’s market share is only 35% with major local rivals such as Airtel and Reliance Jio likely to provide strong pricing pressure.
In fact, Reliance Jio has been making headlines and winning major market share with its recent free offerings, including free 4G service through March of 2017, and after that just 99 Rupees ($1.54) per month.
In a nation with a GDP per capita of just $1,751 per year, Indian consumers are among the most price-sensitive in the world. As a result, well capitalized rivals such as Jio can, and likely will, keep Vodafone India’s margins low for the foreseeable future.
That in turn could wind up resulting in disappointing long-term revenue, EPS, and FCF growth, especially since the telecom industry is monstrously capital intensive.
The transition to 5G technology over the next decade could especially make that true because 5G could end up costing global telecom providers over one hundred billion dollars in new equipment costs.
To give you an idea of the