How safe is Vodafone's dividend?

Vodafone has caught up with the telecoms sector after rallying 18% from its toe-dip below 200p in February, driven by a return to organic growth and 5% dividend yield - enough to get the most satiated investor salivating.

Unfortunately for the blue-chip firm, its bread and butter telecom and content services faces stiff competition, which is bad news for free cash flow (FCF) and potentially that generous payout.

After the mammoth £19 billion "Project Spring" investment programme, Vodafone earmarked a larger capital expenditure (capex) budget than expected in this month's financial results, which pulls 2017 FCF guidance below expectations. The firm must invest in its telecom and content services if it's to keep up with the big-budget competition, but it still predicts FCF of "at least" €4 billion (£3.2 billion) after capital expenditure. That's a lot of cash.

Chief executive Vittorio Colao must also pass rising content costs on to customers, just as the company returns to organic revenue and cash profit growth for the first time since 2008.

"Vodafone said capex/sales will trend higher than management expected six months ago and FY 2017 FCF guidance was below consensus estimates - we are reluctant to think more capex will fuel more FCF," says Haitong Research analyst John Karidis.

Even though Vodafone's average revenue per user is 17% higher than Deutsche Telecom's, the German group isn't backing down quietly, and Vodafone's Italian division is struggling against price-based competition from Three and Fastweb.

In the UK, the tie-up between BT and EE could "materially dent" Vodafone's enterprise business, explains Karidis, and its challenge against Virgin Media could be tricky. So Vodafone cannot rest on its laurels.

But how safe is that prized dividend? When assessing Vodafone's dividend cover, investors should include the "big and recurring" spectrum costs, warns Karidis, which averaged an annual £2.3 billion in the five years to 2016.

Vodafone thinks costs will moderate from the 2017 financial year, although the analyst isn't as confident, pencilling in FCF/dividend per share of 0.5 times, 1.1x and 1.3x in 2017, 2018 and 2019 respectively.

"We think sentiment will stay fragile for good reason but the dividend is safe for now," believes Karidis. He's retained his 'neutral' rating and 210p target price, which now represents 9% downside for the share price.

On an obvious uptrend, the shares have danced between technical indicators so far this year and are currently at a zone of resistance.

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