Why Vodafone and Glaxo are undervalued

Two of the best dividend payers in the FTSE 100 Index — Vodafone (VOD) and GlaxoSmithKline (GSK)  — have been ratcheting up stress levels for income investors in recent weeks.

Anxiety in both cases stems partly from uncertainty over possible major M&A activity, which investors fear could threaten dividends currently yielding 6% and above. Recent share price performances have reflected these jitters, although in the case of Glaxo some of the fog has lifted in recent days.

The pharma giant’s CEO Emma Walmsley bowed to shareholder pressure last week by pulling out of the auction for Pfizer’s consumer healthcare business. Instead, she is spending some of that money on buying out Novartis’ 36.5% stake in their consumer healthcare joint venture for £9.2 billion.

Consolidating ownership in this way has long been seen as one of Glaxo’s two capital allocation priorities — the other being improving the drugs pipeline.

Walmsley says the move will accelerate efforts to bolster the performance of the Sensodyne and Panadol consumer healthcare business, which is well placed to benefit as populations continue to age and healthcare costs rise.

Shareholders loved the developments, especially today’s Novartis announcement as shares rallied by more than 6% to stand at their highest level since October. They are still lower than when Walmsley took the helm last April, but she will have done her standing no harm by listening to the views of shareholders.

Earlier this year, Glaxo indicated that another 80p dividend in relation to this financial year is on the way, maintaining a level of payment dating back to 2015.

UBS has a price target of 1,600p, which is based on 14.8 times 2018 earnings per share (EPS). This compares with a sector multiple of 16x.

Vodafone shares have endured a miserable start to 2018 as investors fret about competitive trading conditions, and the impact of a possible deal to acquire certain European cable operations from US-based Liberty Global.

Barclays reflected those jitters today as it trimmed 2019 earnings estimates and cut its target price to 265p from 280p. That still represents potential upside of 37% and would be the highest level for Voda shares since 2014.

Source: interactive investor                Past performance is not a guide to future performance

The bank’s telecoms analysts note that Vodafone trades on a 2019 price/earnings (PE) ratio of 18.4 times and a 7.5% dividend yield, compared with 15.5x and 5.4% respectively among its peers.

They also see potential synergies worth 25p a share to Vodafone from a tie-up with Liberty Global. However, keeping the debt-to-earnings ratio within a range of 2.5 to 3 times would mean Vodafone needing to raise between 5 billion and 10 billion euros from equity-like instruments such as hybrids.

Shares have also been impacted by a competitive quarter of trading in Europe, with Spain and Italy a particular worry for investors following an update in February.

This dashed the euphoria seen in November after CEO Vittorio Colao upgraded guidance on underlying earnings growth in 2018 — the first time in many years that Vodafone had been able to increase its forecasts.

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