Is Verizon's 6.6% Dividend Yield Sustainable?

Verizon Communications (VZ 0.43%) shares currently yield roughly 6.6%. Investors are often attracted to high-yield stocks for their income potential. However, high dividend yields can sometimes be a sign that the dividend is not safe because market participants often anticipate a cut to the payout in advance.

Recent examples of high-profile companies that have slashed their dividends include Verizon peer AT&T (NYSE: T), which cut its payout nearly in half in 2022, and Walgreens Boots Alliance, which recently reduced its dividend by almost 50%, ending 47 years of dividend growth. Prior to AT&T’s dividend reduction, the stock was yielding more than 8.5%. Walgreen shares were yielding over 7.5% before the company decided to slash the dividend.

Verizon has a moderate dividend payout ratio

Verizon currently pays a quarterly dividend of $0.665 per share, which equates to $2.66 on an annual basis, and it expects fiscal 2024 adjusted earnings per share (EPS) of $4.50 to $4.70. Thus, the company has a payout ratio of roughly 58%. Adjusted EPS is an appropriate measure to use to get a sense of the business’s true earnings power because it excludes the impact of one-time events such as restructuring charges and legal settlements.

This moderate payout ratio means that Verizon has a significant amount of wiggle room should the company experience unexpected adversity. Additionally, the reasonable payout ratio means that the telecom giant may be able to further increase its dividend going forward.

Predictable cash flow due to limited cyclicality

Phone and internet service are essential for most individuals and businesses, and people don’t generally cut them, regardless of economic conditions. Additionally, the cost of those services is fairly low relative to other consumer and business expenses.

That said, Verizon is not immune to the impact of a broader economic downturn. People sometimes opt to downgrade their service level, and some businesses close down, which can be a headwind. During the most recent economic slump — the COVID-19-induced 2020 recession — Verizon reported a modest decline in revenue, with fiscal 2020 sales dropping 2.7% from the previous year.

However, Verizon’s relatively low degree of cyclicality reduces the risk that the company will be forced to cut the dividend due to sudden weakness in the broader economy.

Tight market structure with high barriers to entry

The U.S. wireless phone market, which is Verizon’s biggest business, is an oligopoly dominated by Verizon, AT&T, and T-Mobile. Verizon has a roughly 29% market share, while AT&T and T-Mobile account for about 47% and 24%, respectively.

Historically, Verizon has positioned itself as a premium carrier focused on providing a best-in-class network. T-Mobile has presented itself as the value player in the space and has gained market share by offering low prices. Meanwhile, AT&T has been somewhere in the middle, with a focus on aggressive device promotions that has helped sustain market share but resulted in some profitability challenges.

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Over the past few years, Verizon has lost some market share as the difference in quality between its network and AT&T’s and T-Mobile’s networks has narrowed. However, Verizon has gotten more aggressive in terms of promotions recently and appears to have turned the corner. During Q4 2023, the company reported 318,000 postpaid phone subscriber net additions. In the previous three quarters, the telecom experienced postpaid phone subscriber losses.

The broadband business is similar in nature to the wireless business because Verizon’s broadband offering competes with select cable players in each market. In addition to having relatively limited competition currently, the telecom arena has very high barriers to entry due to massive capital expenditure and network requirements. Recently, a number of cable companies have entered the wireless phone market through mobile virtual networks, but they lease network space from Verizon, AT&T, and T-Mobile, so the threat from these players is fairly low due to their higher cost structure.

The combination of limited competition and high barriers to entry is a positive for Verizon because it reduces the risk that the company will face new competitive threats.

Risks to the dividend to watch out for

One potential risk to Verizon’s dividend comes from the company’s relatively high leverage levels. As of Q4 2023, the telecom titan had a net leverage ratio of 2.6. Net leverage is a metric that attempts to assess a company’s ability to meet its debt obligations. All else being equal, a higher net leverage ratio means it is more difficult for a business to meet its debt obligations.

In this case specifically, net leverage is a company-provided metric that divides Verizon’s total unsecured debt minus cash and cash equivalents by adjusted EBITDA for the trailing-12-month period. While the telecom’s debt maturities are staggered so repayment shouldn’t be an issue, a prolonged period of elevated interest rates has the potential to lead to higher interest costs.

Currently, the average rate on Verizon’s debt is 4.9%, which is well below short-term U.S. government debt rates. In the event that interest rates remain elevated or climb from current levels, Verizon is likely to experience rising interest costs over time. That could reduce net income and lead to less free cash flow that can be used toward the dividend.

To get a sense for why this is a risk, consider the fact that Verizon reported fiscal 2023 net income of $12.1 billion and interest expense of $5.5 billion. Thus, even a 20%-30% increase in the company’s interest expense has the potential to substantially reduce net income. However, I view this risk as manageable given the fact that the business has prudently staggered its debt maturities.

Investor takeaway

I view Verizon’s dividend as fairly safe due to the low payout ratio, limited cyclicality of the underlying business, and oligopolistic market structure of the U.S. telecom industry. However, investors should continue to monitor interest rates, because a prolonged period of much higher interest rates would result in significantly higher interest expense for the company, which could reduce the amount of cash available to pay the dividend.

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