Is Vodafone still worth dialling into?

Vodafone at 254p. Pull this one – its got bells on it and many other things as well including a good and sustainable dividend yield.

Do you have bells wringing in your ear? Buzzing noises in your head? Or perhaps your day is punctuated by the sound of Beethoven’s ‘Ode to Joy’ or Mozart’s ‘Jupiter Symphony’ played in the manner of a rather tinny Victorian musical box on the ‘Antiques Road Show’? I am of course referring to your digital device or as a related alternative, the accounts of Vodafone (VOD), which are hard to comprehend.

A year or so ago it was much easier to value Vodafone because it had that near majority holding as a trade investment in the US company Verizon which was to fall like an over ripened peach, into to the laps of Vodafone shareholders, once it was sold. That fall is now history and we have to value Vodafone by the usual yardsticks. (By the way, I suggest you have a tune by Mozart as the ring tone on your modern, multitasking digital device because some researchers seem to think that it will make your brain smarter, because Mozart, God bless his little cotton Salzburg socks, reaches part of your cerebral vertebrae that even J.S. Bach does not touch, thus improving your brain function and power considerably. Beethoven by contrast, like the Rolling Stones, will only make you deaf and also romantic in an early-nineteenth-century sort of way.

I took a butcher’s at Vodafone having spotted the news that it was being connected to Liberty International, the $18 billion revenue TV cable company which – as market rumour mongers said – it was going to acquire. Vodafone now tell us that an acquisition of Liberty is not the plan. Instead, it’s in talks with Liberty on the potential of an asset swap in national territories of interest to each company. This seems to be part of the latest fashion for electronic media and communication companies to become multi-service, multi-product suppliers of voice mail (what we used to call the telephone), digital data access and transmission, videos and films, land line services and mobile service etc. All those things which are turning us into a species with the attention span of a gnat.

The services provided by companies like Vodafone grow diversely, totally unlike the equity model, with more products and services. Looking down the menu of services provided by Vodafone seems to include the financial services of  money receipt and transmission and the distribution of wages and salaries, plus a device which manages your other smart devices; a bit like an electronic hand held butler that supervises your other electronic servants. Land lines merge into mobile lines and data transmission along with those voice mail calls to your aunty Gladys all combine to create a top line sales revenue mix of £42 billion.

Checking the market consensus estimates of Vodafone’s financial future I was pleased to see that the shares at a share price of 245p (last seen) are valued at a prospective, estimated dividend yield of 4.5% for this year and 4.6% for next year to 31st March 2017. The problem, however, is that the accompanying estimated price to earnings ratios are an eye watering and knee trembling 49 times this year’s estimated earnings 5.66p and 39 times next year’s consensus estimated earnings per share figure of 6.55p. As the dividend payout will be an estimated 11.6p this year and 11.7p next year, it does not need a sleuth of the sharpest acuity to detect that these dividend estimates are not covered by estimated earnings but will instead, if paid, have to come out of capital. So should the shares be bought at this level?

Here, we come to the important fact that Vodafone is investing in the business at a rate made possible initially, by the Verizon inheritance and for the moment, earnings per share figures seem secondary; something a company can afford if it had has a big enough dividend yield to support the share price and providing that the dividend pay out looks sustainable and believable. The industry is going through a period of defining consolidation.

In the case of Vodafone, the sustainability of the dividend pay out looks well supported by the operating cash flow the business is generating. Whereas earnings per share was calculated as being underlying consensus earnings per share of 5.55p, operating cash flow last year, was reported at £9.7 billion which computes as being worth some 35p a share. The business looks very much as if it is being managed with the longer term future in mind and for cash returns, rather than earnings. In that light, we can see that Vodafone shares are valued at 7 times last year’s operating cash flow which  covered the dividend paid last year by more than three times.  Moreover, that strong cash flow position is reflected by the £10.7 billion sitting in the company balance sheet last year, which I estimate to be worth over 38p a share.

The shares also have the support of a low “price to book value.” That is to say the relationship between the share price and the balance sheet assets attributable to ordinary shareholders; otherwise known as the net assets or the equity. In the case of Vodafone, the equity value of the balance sheet is reported as £66 billion which is large in relation to the market capitalisation of the equity in the market at £68 billion most recently seen. That means, investors are now paying very little for earnings because of the big balance sheet asset value. However, note that £22.5 billion of those assets were ‘goodwill’ and another £21 billion were ‘intangible’ assets. However, that does not seem to undermine the validity of the price to book measure of value which is one of the cornerstones of fundamental investing.

In conclusion, as the Vodafone share price moves down it should find the support of the ‘bottom rung’ of its current uptrend. I would expect chartists at that point to sit up and take notice like Meerkats.