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Vodafone (LSE:VOD) shares now offer the highest dividend yield within the FTSE 100 following last week’s drop after its management released earnings. The telecommunications giant failed to impress with its newly deployed strategy of righting the ship. Yet the news wasn’t all bad. And following the recent disposal of its Spanish business, dividends look like they could be funded for the next few years. So is now the time to start buying shares?
After borrowing heavily to fuel the expansion of its telecommunication infrastructure, Vodafone is feeling the pinch of rising interest rates. And the board ultimately decided to bring in Margherita Della Valle as the new CEO to try and fix the problems.
So far, she’s off to a mixed start.
As previously mentioned, the group decided to sell its Spanish operations in a €5bn deal with Zegona Communications. As part of this transaction, Vodafone will also continue providing services to Zegona, generating an estimated €110m in annual recurring revenue.
Another encouraging sight is that Germany – Vodafone’s core market – has finally returned to growth! Sales in the second quarter grew by a modest 1.1%. That’s hardly spectacular, but for a region that’s been in decline for a while, it’s a welcome change of pace.
Meanwhile, revenue generated from services worldwide was up by 4.2%, with Africa the main star of the show, delivering 9% growth.
Management subsequently decided to continue maintaining dividends. Shareholder payouts haven’t grown since 2019. And while I’m sceptical that this will change anytime soon, analyst consensus seems to place the dividend in high regard for the next couple of years.
That certainly makes today’s near-11% dividend yield look attractive. But, sadly, there are some caveats to consider.
The bear case
Seeing Germany return to growth is obviously promising. But a closer inspection reveals this was achieved through price hikes rather than the acquisition of new customers. And there are limits to what Vodafone can charge before customers start switching to cheaper alternative providers. After all, the company’s hardly short on competition.
Another concerning factor is the state of underlying profitability, with margins shrinking 0.8% to 29.1% on the back of rising energy costs. While that certainly sounds understandable, some of its competitors have managed to expand margins nonetheless.
Management has begun addressing the profitability problem through employee layoffs. So far, 2,700 workers are already out the door, with another 8,300 expected to follow over the next three years. But this strategy could backfire. If Vodafone eliminates too many roles, the quality of service could suffer, resulting in customers switching to better-staffed businesses.
To buy or not to buy?
Della Valle seems to be keeping her promise of returning Germany to growth. Yet the rest of the business is still in need of some tender loving care. Disposing of underperforming assets will help simplify operations. But it also eliminates sources of income and creates new opportunities for well-financed competitors to take market share.
Personally, I want to see more progress made under the new strategy before considering buying this business. Even if the dividend yield is maintained, continued deterioration of the company will send the share price in the wrong direction, undoing any passive income gains.