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Founder and CEO

Vodafone – the canary in the coal mine?

It was announced earlier this week that Vodafone, one of the most important and popular income stocks in the UK, is to cut its dividend by 40% as a result of high-debt levels and the costly effect of 5G rollout. The share price has already fallen c.19% year-to-date as investors have become increasingly concerned about its dividend and overall leverage – and the risk is this trend continues.

We sold the stock within the Neptune Income Fund early last year for a variety of reasons – but effectively, it came down to our view that by holding the company, we were putting both our investors’ income and capital at risk. We felt the company had unsustainable leverage on the balance sheets (which was built up to fund inorganic expansion), a new breed of agile companies disrupting its business model and changing pricing structures – meaning investors can no longer rely on the company to provide sustainable dividends and capital appreciation. Effectively, our view was that Vodafone was entering a difficult operating backdrop with limited capital available to react to changes in its competitive landscape and to meet its capital expenditure requirements.

We sold the stock within the Neptune Income Fund early last year for a variety of reasons – but effectively, it came down to our view that by holding the company, we were putting both our investors’ income and capital at risk.

Our rationale for selling Vodafone, and its subsequent dividend cut (which has gone handin-hand with a sharp share price fall) illustrates the way we think about income investing well. Our approach has, and continues to be, to deliver an attractive yield, but just as importantly, delivering a growing income stream whilst protecting capital. We are fully aware of the challenging environment for UK income investors, with the FTSE All Share Index’s pay-out ratio increasing to unsustainable levels. On top of that, it is a highly concentrated market, with just 10 companies (of which Vodafone is one of them) producing c.50% of the Index’s yield. Given these challenges, we believe it is highly important to try and protect income and capital and to not chase yield.

Vodafone Share Price

Source: Bloomberg as at 15.05.19. References to specific securities and sectors are for illustration purposes only and should not be taken as a recommendation to buy or sell these securities or sectors. Neptune funds are not tied to replicating a benchmark and holdings can therefore vary from those in the index quoted. For this reason the comparison index should be used for reference only. Past performance and forecasts are not an indicator of future performance.

The Neptune Income Fund’s key advantage, in our opinion, is that fact it is managed via an equally-weighted 33-stock portfolio, unlike the majority of UK equity income funds that take a barbell approach – meaning they effectively load-up on a small number of high-yielding stocks to generate their overall yield.

The dangers of a barbell approach are shown by the impact Vodafone’s dividend cut has had on the market as whole. We estimate that the stock’s 40% dividend cut will reduce the FTSE All Share Index’s yield by 1.65% and the overall IA UK Equity Income Sector’s yield by 1.11%. Despite its poor share price performance and concerns surrounding the sustainability of its dividend, the stock is held by more than 50% of IA UK Equity Income funds and, on average, it accounts for 5.42% of their overall yield. As such, by cutting its dividend, we estimate that those funds – on average – will see their yield fall by 2.15%.

Vodafone Tabe 1

Source: Morningstar as at 30.04.19. References to specific securities and sectors are for illustration purposes only and should not be taken as a recommendation to buy or sell these securities or sectors. Neptune funds are not tied to replicating a benchmark and holdings can therefore vary from those in the index quoted. For this reason the comparison index should be used for reference only. Past performance and forecasts are not an indicator of future performance.

This all illustrates the disproportionate effect a dividend cut (bearing in mind, it is only 40%) from a popular stock can have on the UK income market. We believe Vodafone’s announcement should be viewed as canary in the coalmine moment for UK equity income investors and we expect many other supposedly “safe” UK dividend-paying companies to follow suit as a result of falling levels of dividend cover. We would put the tobacco majors Imperial Brands and British American Tobacco, BT and the major utilities stocks in that category – in fact we are the only IA UK Equity Income Fund to have 0% exposure to utilities and to not hold the aforementioned stocks and Vodafone.

Stock Metrics

Source: Morningstar as at 30.04.19. References to specific securities and sectors are for illustration purposes only and should not be taken as a recommendation to buy or sell these securities or sectors. Neptune funds are not tied to replicating a benchmark and holdings can therefore vary from those in the index quoted. For this reason the comparison index should be used for reference only. Past performance and forecasts are not an indicator of future performance.

Indeed, as with companies such as General Electric have had to do in the past, we believe it is highly likely Vodafone will not be paying a dividend at all in the coming years as management attempt to shore up the business. In the meantime, the message is clear – chasing yield in the current environment is dangerous and, instead, investors must focus on companies that are growing earnings and can therefore easily cover their dividends to make sure their own income stream’s and capital are protected.

Investment risks
The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the original amount invested. Please remember that forecasts are not a reliable indicator of future performance. The content of this is formed from Neptune’s views as at the date of issue. We do not undertake to advise you as to any change of our views. Neptune does not give investment advice and only provides information on Neptune products. Please refer to the Prospectus for further details.

Founder and CEO

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