Over the last few years, Vodafone’s shares have undergone quite a transformation, with the price plummeting from 240p in 2018 to approximately 75p at present. Meanwhile, the dividend yield has taken an interesting turn, recently crossing the 10% threshold. As an avid dividend investor, such a figure couldn’t escape my attention, and it propelled Vodafone to a respectable fourth place on my list of high-yield blue-chip UK stocks.

It’s quite clear that Vodafone’s attractive dividend yield is an eye-catcher, but what remains uncertain is its sustainability. This is the pivotal question I aim to tackle in this discussion.

Note: If you’re not familiar with Vodafone, it’s a notable FTSE 100 company, boasting the largest mobile network operations across Europe, along with a substantial presence in Africa. The company also offers a wide spectrum of telecom-related solutions for businesses, encompassing cloud computing to IoT (Internet of Things).

Scrutinizing the Dividend’s Foundations

The foundation of any strong dividend stock is consistent profit generation, wherein profits are not only positive but also surpass the dividends being paid out. Here’s my benchmark:

Golden Rule: Invest only if the company has reported profits for every one of the past ten years.
Golden Rule: Invest only if the cumulative earnings over the last ten years exceed the total dividends.

Unfortunately, Vodafone stumbles at the very first hurdle, failing to meet both these criteria. Notably, it incurred losses in four of the past ten years. Additionally, its ten-year dividend cover, including cash distributed via share buybacks, stands at a mere 0.4. In simple terms, Vodafone paid out more in dividends than it managed to generate in profit. This raises serious doubts about the sustainability of the current dividend, unless significant strides are made in bolstering earnings.

Unveiling the Reasons Behind Vodafone’s Losses

A closer look at Vodafone’s loss-making years reveals a recurring pattern, largely attributed to the fallout of past acquisitions. For instance:

– 2016 (£3.8 billion loss): Primarily due to a £0.5 billion goodwill impairment in Vodafone Romania and a £3.2 billion reduction in deferred tax assets tied to Luxembourg operations.
– 2017 (€6.1 billion loss): This loss was linked to tax impairments from acquisitions in Luxembourg and India.
– 2019 (€7.6 billion loss): Acquired goodwill impairments in Spain and Romania, coupled with impairments post the disposal of Vodafone India.
– 2020 (€0.5 billion loss): Mainly owing to goodwill impairments in Spain, Ireland, and Romania, along with writing off the value of Vodafone’s stake in Vodafone Idea.

Vodafone’s losses are predominantly tied to adjustments in acquired goodwill and deferred tax assets, both of which are associated with historical acquisitions.

Vodafone’s Acquisition Journey: A Blessing or a Curse?

Vodafone’s history, built upon a series of mergers and acquisitions in the 1990s, holds crucial implications for dividend sustainability. On one hand, companies formed through acquisitions often exhibit complexity and fragility, akin to a car assembled from disparate parts. This is not ideal for ensuring sustainable dividends and growth.

On the other hand, Vodafone’s losses, primarily attributed to goodwill write-downs, haven’t hindered its ability to pay dividends. Such losses might not significantly impact the company’s cash or its dividend-paying capacity. Therefore, despite repeated losses, Vodafone’s dividends have remained largely unaffected.

Nevertheless, focusing on adjusted earnings provides a clearer picture of operational performance. Adjusted earnings exclude non-cash one-off expenses such as goodwill impairments, offering a truer glimpse into underlying performance.

Analyzing Vodafone’s adjusted earnings reveals a grim reality. Despite the improved appearance, adjusted earnings consistently fell short of covering the dividend over the past decade. This indicates that dividends were often not backed by earnings, raising concerns about the source of cash used for dividend payouts.

Uncovered dividends typically prompt additional debt or asset sales for funding, neither of which is sustainable in the long run. Vodafone’s dividend coverage being inadequate remains a significant red flag.

Dividend Growth and Profitability: The Missing Pieces

Sustainable dividend growth necessitates a chain reaction – earnings growth relying on revenue growth, fueled by asset growth, itself linked to equity growth. In Vodafone’s case, this chain has faltered. Over the past decade, Vodafone’s equity, revenues, earnings, and dividends have all witnessed declines. This is far from the growth trajectory expected of a quality dividend stock.

The yardstick I use indicates that a ten-year growth rate exceeding 2% across equity, revenues, and dividends is essential. Regrettably, Vodafone’s dividend has been slashed twice in the past decade to match dwindling earnings. Coupled with the dearth of revenue growth, sustainable dividend growth seems an improbable aspiration.

Profitability is equally concerning. A quality company should consistently yield double-digit net returns on capital, indicating efficient utilization of resources. Unfortunately, Vodafone’s net returns on capital barely crossed 2% on average over the past ten years. This deficiency undermines the company’s quality as a dividend stock.

The Heavy Burden of Capital Intensity and Debt

Vodafone’s capital-intensive nature is another cause for alarm. The company must allocate substantial resources into maintaining and upgrading its extensive physical infrastructure. Over the last decade, Vodafone spent a colossal €92 billion on capital expenditures, dwarfing its adjusted earnings of €27 billion. This imbalance – capex at 337% of earnings – is a glaring red flag.

Furthermore, Vodafone’s debt levels are alarming. My guideline is to keep debt under five times the average earnings over the past decade. Unfortunately, Vodafone’s debt-to-average-earnings ratio has consistently exceeded this level, averaging a staggering 22.

The Impending Verdict: Is Vodafone a Quality Dividend Stock?

The comprehensive analysis leaves me with a firm conviction that Vodafone falls short of the mark as a quality dividend stock. The company’s losses, weak returns on capital, substantial capital expenditures, and exorbitant debts collectively point to a dividend that’s far from being on solid ground.

However, Vodafone’s story may rewrite itself in the future. With a new CEO at the helm and ambitious transformation plans in place, positive change could be on the horizon. While I fervently hope for Vodafone’s turnaround, for now, it finds its place on my list of uninvestable stocks.