The Best Large-Cap Income Opportunity I Can Recall

Published in Company Comment on 31 May 2012

Just how large will future dividends from Vodafone be?

Representing about 6% of the FTSE 100, Vodafone (LSE: VOD) is one of the biggest and best dividend payers in the blue-chip index -- and that payout is growing at an impressive rate. Throw in special dividends, and Vodafone could be the best income opportunity in years.

For 2011, shareholders received 8.90p per share from Vodafone. For the year ending March 2012, this figure rocketed to a massive 13.52p.

There are two reasons for this large rise. The first is growth in Vodafone's ordinary dividend. The second is a 4p special dividend for 2012.

Dazzling dividend

For 2010, Vodafone's dividend was 8.31p per share. Around that time, the company announced its intention to grow the payout by 7% per annum for the next three years. If Vodafone can meet this target for 2013 (Vodafone has a March year-end, so we are in Vodafone's 2013 now), then the ordinary part of the dividend would hit 10.2p per share. At today's share price, that alone is nearly a 6% yield.

The kicker here is the possibility that the additional 4p special dividend may be repeated.

The special dividend came from Verizon Wireless (NYSE: VZW.US). VZW is a US mobile network operator formed as a joint venture between Vodafone and Verizon Communications. Vodafone has 45% of VZW and Verizon Communications owns the rest.

Verizon holds the key

Until recently, VZW had been using the cashflows in its business to finance acquisitions and investment. This changed last year when VZW announced it would pay its owners a dividend. Vodafone's share of this amounted to £2.8bn for 2012. Vodafone then used the VZW dividend to pay its own shareholders a £2bn special dividend.

Vodafone is the junior partner in VZW. Verizon Communications decides whether VZW pays a dividend or not. To ascertain the future income stream Vodafone represents, investors must get a measure of the probability and magnitude of dividends from VZW.

I spoke with Tom Gidley-Kitchin, the Vodafone analyst at stockbroker Charles Stanley. Tom researches Vodafone and its industry day-in, day-out. So how does he assess the dividend situation at Vodafone? Tom says:

"While Vodafone has committed to increasing its ordinary dividend by 7% per annum next year, there is no such public commitment from VZW to its shareholders.

"VZW is producing more than $1bn of free cash per month. Unless VZW spends this money on acquisitions, I envisage continued dividend payments to Vodafone."

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VZW has a net cash position. The company is also enjoying large revenue growth. Consensus estimates of Vodafone's future dividends reveal a number of analysts are expecting special dividends to be paid during the next two years.

If VZW pay Vodafone again in 2012, the dividend to Vodafone shareholders could hit 14.2p (10.2p ordinary dividend, 4p special). At today's price, that's a massive 8.4% yield. Normally when a company is paying that level of dividend there are concerns on its sustainability. Of course, VZW might not pay out. Even in this scenario, however, Vodafone could still pay the normal 10.2p dividend.

Currently, it feels like investors are looking at Vodafone in a 'glass half-empty' mood. More bullish investors might think that, just as Vodafone has increased its normal dividend to shareholders, it might be possible for VZW to increase its dividend to Vodafone as well.

(No doubt the effect of VZW has crossed the mind of City dividend legend Neil Woodford, who counts Vodafone as one his largest income holdings. You can read more about Neil Woodford's market-beating dividend portfolio in this free report: "8 Shares Held By Britain's Super Investor")

Vodafone is a dominant player in its markets. This position brings high visibility of earnings, something investors usually pay a premium for. With the normal dividend already substantial and the possibility of more special dividends, Vodafone looks the best large-cap income opportunity I can recall in a long time.

David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors Of 2012" -- while it's still free!

Further investment opportunities:

> David does not own shares in any of the companies mentioned here.

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Comments

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Avalaugh 31 May 2012 , 12:47pm

Will be looking to top up during the euro carnage,

dpeddlar 31 May 2012 , 1:34pm

We are in the thick of the euro crisis, i would buy at least some now encase they sort things out - don't miss the boat, its a good company at a good price and it does not get much better than that

sageofnw6 31 May 2012 , 3:59pm

Tend to agree but have a slight concern about the growth of wi-fi networks and how they may constrain growth in mobile telecoms in the future. At the moment though, usage of smartphones still has a long way to go.

Maddoxx 31 May 2012 , 10:47pm

Spot-on David.

The market has discounted Vodafone's prospects for special dividends funded by dividends from its 45% ownership of Verizon Wireless.

Most analysts took Lowell McAdam, Verizon Communications’ (Verizon Wireless' 55% owner) new chief executive, at his word when he told the Financial Times it was not possible to have a policy of annual dividend payments by Verizon Wireless because the leading US mobile operator may need to buy rival businesses or purchase radio spectrum <http://www.ft.com/cms/s/0/1c440fb4-db0f-11e0-bbf4-00144feabdc0.html#axzz1wU2xm8dE>

No prospect of regular special dividends then.... Well not quite. Whilst Verizon Wireless doesn't have a regular payout policy - Verizon Communications the parent company does - in fact it has a progressive dividend policy. And, as the parents' business is not growing it will become increasingly dependent upon dividend payouts from Verizon Wireless to fund its own dividend policy.

So, when Verizon Communications needs its cash fix Vodafone will get its 45% of the dividends paid.



ANuvver 31 May 2012 , 10:48pm

An awful lot of people are waiting for euro carnage, which is why price support across the board is so flaky.

We may not be at the fabled point of maximum pessimism yet, but the sidelines are getting very crowded (some are even paying to stand waiting). People seem to be expecting a definitive event - as though someone is going to look at a watch, check with the linesmen and blow time. Then the pitch invasion. Well it never quite plays out like that.

VOD is one of my biggest holdings, and I'm perfectly happy with it.

ANuvver 31 May 2012 , 11:02pm

Maddoxx:

Agreed. I look for progressive payout policies but assess my portfolio on trailing yield and make an exception for VOD, discounting the special as a one-off. I think it likely that there's more to come, but I can't plan around it, so I'd rather regard it as a nice surprise as and when.

I prefer my surprises to be on the upside if possible.

sopavest 01 Jun 2012 , 6:44am

@sageofnw6

I think that the wi-fi vs. mobile concern has been around for a few years now, but the promised land of free wi-fi everywhere hasn't materialised -- where there are widespread public wi-fi networks, you usually have to pay and they're often run by mobile companies.

I think that wi-fi and mobile serve two different purposes and I believe they will live happily alongside each other going forwards.

Roland
(Disclosure: I hold Vodafone)

mcturra2000 04 Jul 2012 , 7:42am

I look at it this way. Investors are getting far more from the VOD divvies than they are from deposit accounts. It's as safe and steady a business as anything gets (mind you, so was TSCO, and look what happened to that). So why not hold VOD? Sure the Euro could collapse, and this, that and the other may happen, but let's be clear here, no-one really knows. You could be waiting for a crash that never happens.

I do own some VOD. Its share price movement is, shall we say, glacial.

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