One of the first trades in my portfolio this year was buying into telecoms giant Vodafone (LSE: VOD). The share price has slumped 24% in a year. It has been trading near a 12-month low over the past few weeks. That could suggest no recovery is yet in sight and the price may continue to move lower. However, I have taken advantage of the crash to buy Vodafone shares. Here are three reasons why.
1. Underlying business strength
Vodafone clearly has some problems, as suggested by the fall in its share price. One of the most troubling for me is it large debt.
Net debt stood at €46bn at the end of September. The company announced this week that selling its Vodafone Hungary business will help fund some debt reduction, although the cash consideration of €1.7bn will hardly dent the debt pile. Bigger solutions are needed.
But telecoms is an expensive business. Building and maintaining licensed networks requires heavy capital expenditure. The benefit of that is it imposes high barriers to entry and helps keep competition low. As a consumer, I dislike that — but from an investment perspective it can be rewarding.
Vodafone operates in dozens of markets across Europe and Africa, serving over 300m customers. Digital demand is set to keep growing. Vodafone’s customer base and strong brand can help it benefit from that.
2. Attractive valuation
The current Vodafone share price has room for growth, in my opinion.
The price-to-earnings ratio of 9 looks undemanding. The company has a market capitalisation of £24bn. Even considering the debt, that looks cheap for a massive telco that last year generated a €2.6bn profit. That is one reason I bought the shares this month, for pennies apiece.
3. Juicy dividend
A company’s dividend yield is expressed as a percentage of the current share price. So a falling share price has the effect of pushing up yield.
That means right now I can buy Vodafone shares and anticipate a yield of 8.7%. Vodafone is not the only telecom company with a juicy yield. BT offers 6%, for example. But the Vodafone yield is still unusually high. Indeed, it was a key reason for my share purchase.
To fund dividends, a company needs to generate sufficient free cash flow. Vodafone’s balance sheet looks unhealthy to me and there is a risk it may cut its dividend to service debt. The company has form in this area, having slashed the payout in 2019. But even if it made a similar cut this year – of around 40% — the prospective yield at today’s price could still be over 5%. That is still attractive to me, though less exciting than 8.7%.
I think the depressed Vodafone share price suggests that many investors already expect a cut. So if it comes, the shares may actually recover some ground as the City refocuses on the underlying investment case. If, as I hope, there is no cut then, as a shareholder, I could benefit from juicy dividends.
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C Ruane has positions in Vodafone Group Public. The Motley Fool UK has recommended Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.