Vodafone (VOD) is an uncommon stock. It has a high dividend yield of 6%–roughly three times the average dividend yield in the S&P 500. And, it has a long history of raising its dividend.

Vodafone is headquartered in the U.K. Its dividend payments fluctuate based on prevailing exchange rates.

But it would be on the list of Dividend Aristocrats, if its dividend payments were measured in its own currency.

The Dividend Aristocrats are a set of 50 companies in the S&P 500 that have raised their dividends for at least 25 years in a row.

Vodafone not only maintains a high yield, but it also grows its payout steadily over time.

That combination is the “secret sauce” of dividend stocks that could produce excellent long-term returns.

This article will review Vodafone’s business model and how the company can sustain its high yield going forward.

Business Overview

Vodafone is a telecommunications company. It provides voice, messaging, and data services across its wireless network. It also offers television and Internet services.

The company has more than 460 million mobile customers, as well as 13 million broadband and 9.5 million television customers. It operates in 30 countries around the world, and partners with networks in another 50 countries.

The current environment remains challenging for Vodafone. Its core European market is struggling with low economic growth and a heightened level of uncertainty due to the Brexit vote.

Plus, foreign exchange is an added headwind. Vodafone’s net revenue and EBITDA declined 3.9% and 1.7%, respectively, through the first six months of 2016.

The declines were due entirely to currency. Vodafone has a significant presence outside Europe. Approximately one-third of its total revenue comes from Africa, the Middle East, and Asia-Pacific.

Excluding foreign exchange, Vodafone’s revenue and EBITDA actually increased 2.3% and 4.3%, respectively.

Still, despite a difficult economic climate, Vodafone is adding customers and its revenue growth is accelerating.

Source: Half-Year 2016 Presentation, page 5

This indicates the core underlying business remains healthy, since currency is a purely financial effect.

Vodafone is also effectively managing costs. Margins are expanding, which has led to EBITDA growth above its revenue growth rate.

Source: Half-Year 2016 Presentation, page 29

High margins help the company generate strong cash flow. This can be used to help maintain a satisfactory financial position.

Vodafone expects to reduce its net debt by $2 billion in 2017. It intends to use excess cash flow to pay down debt and strengthen its balance sheet, which will help protect its dividend.

The company forecasts a 1.7% dividend increase for the first half of 2017.

Vodafone’s fundamentals are strong. And, the company has a positive outlook going forward thanks to growth in the emerging markets.

Growth Prospects

Telecoms are usually stodgy, low-growth companies. But Vodafone is generating solid growth. One reason for this is because of the company’s massive network build-out over the past several years.

Source: Half-Year 2016 Presentation, page 6

In the past three years, Vodafone invested 47 billion euros (about $50.5 billion at prevailing exchange rates) in capital expenditures, acquisitions, and spectrum and licenses.

Vodafone’s network investments have paid off. The company is in prime position to capitalize on the growth in data.

Source: Half-Year 2016 Presentation, page 9

Data is a major growth catalyst for Vodafone going forward, driven by better availability, reliability, and speed of mobile networks.

Data traffic rose 61% through the first six months of 2016.

Vodafone has a heavy presence in several emerging markets. For example, it has 200 million customers in India, good for 22% market share.

India is a particularly attractive market for Vodafone. It has a large population of over 1 billion. It has a significant population of younger consumers.

And, India’s economy is growing at a high rate. This is all great news for Vodafone’s India business.

Source: Half-Year 2016 Presentation, page 20

There is plenty of runway left for continued growth in these markets. Many of these markets still have high rates of 2G and 3G network usage.

In Vodafone’s AMAP geographic segment, smartphone usage has only eclipsed 50%.

More than one-third of customers in AMAP are on 2G or 3G data networks. Just 4% of these customers have 4G.

As 4G rollout spreads in these nations, Vodafone should reap increasing revenue from higher data usage. Following an Indian spectrum auction in October, the company increased its spectrum holdings there by 61%.

Vodafone is rapidly adding spectrum and customers in India. Its emerging-market growth should lead the company going forward.

This is already starting to happen. Over the first half of 2016, service revenue in AMAP rose more than 7%.

Valuation & Expected Total Return

One potential downside for Vodafone stock is that it has an elevated valuation. For example, the company is expected to generate earnings-per-share of $0.90 in 2017.

Based on its recent share price, the stock trades for a forward price-to-earnings ratio of 28. By comparison, the S&P 500 Index has a price-to-earnings ratio of 25.

This indicates the stock is overvalued. Typically, telecom stocks hold below-average multiples because of their low growth rates.

That said, Vodafone’s impressive growth justifies an above-average valuation. Earnings-per-share are projected to increase 20% in 2017.

This is a much higher rate of earnings growth than many U.S. telecoms are able to muster. As a result, Vodafone appears to be fairly valued.

Going forward, expected returns will come from earnings growth and dividends. A reasonable breakdown of Vodafone’s future returns could be as follows:

• 3%-4% organic revenue growth
• 1% earnings growth from cost cuts
• 6% dividend yield

Under this scenario, Vodafone stock could return 10%-11% each year. Not surprisingly, Vodafone’s high dividend yield constitutes a significant portion of its expected returns.

Final Thoughts

Vodafone’s 2016 financial results don’t look impressive, but currency is making the situation look much worse than it is.

Excluding currency fluctuations, Vodafone is performing very well. Its European operations are highly profitable, and the company is reaping excellent growth in the emerging markets like India.

Vodafone has a hefty 6% dividend yield, and offers dividend increases each year. It is an attractive high-yield stock in the telecom sector, especially for investors looking for exposure to the emerging markets.