Investors need to keep an eye on the company’s debt load.
Verizon Communications (VZ 2.03%) stock currently offers investors a generous forward dividend yield of 6.6%, supported by the company’s unwavering commitment to return cash to shareholders. In September 2023, Verizon boosted its dividend 2% to $0.665 per share, its 17th consecutive year of dividend hikes.
Sometimes a high yield is masking underlying financial difficulties. Since dividend yield and stock price are inversely related, a low price could reflect deteriorating financial conditions. Dividends also are not guaranteed to continue. Declining earnings and/or increased leverage could force a company to eliminate or reduce its dividend.
Given its high dividend yield, should investors be concerned about the safety of Verizon’s dividend?
Earnings stability provides sufficient cash flow to cover the dividend
Although Verizon’s broadband and wireless sectors are showing promising long-term growth, its core business is stagnant, resulting in lackluster earnings growth. Uninspiring earnings per share (EPS) growth, however, doesn’t mean the dividend is in jeopardy. Verizon’s telecom properties generate highly predictable and stable earnings before interest, taxes, depreciation, and amortization (EBITDA) and free cash flow.
The company’s revenue remained consistent throughout 2023 and the first quarter of 2024, when the company narrowly missed consensus expectations. This is significant, as dividends and/or share buybacks are paid from a company’s free cash flow.
However, a review of Verizon’s first-quarter earnings report shows that its ability to generate strong free cash flow is more than sufficient to cover its dividend.
Verizon notched $7.1 billion in cash flow — a decrease from $8.3 billion for the same period the prior year. However, its capital expenditures decreased by $1.6 billion, resulting in a net free-cash-flow position of $2.7 billion, a healthy 17% increase over the first quarter of 2023 and enough to cover its first-quarter dividend.
Verizon’s dividend cost it $11 billion in 2023. The company earned $18.7 billion in free cash flow in 2023, a $4.6 billion increase over 2022. Verizon paid out about 60% of its free cash flow in dividend distributions in 2023, providing a healthy margin of safety for investors looking for a reliable stream of future income.
The company’s high debt level is cause for concern
The one blemish that detracts from the high-yield investment thesis is the company’s staggering $151.7 billion in total debt. Due to high interest costs, this level of debt diminishes Verizon’s ability to maximize free cash flow.
The company’s debt-to-equity ratio is 1.86, lower than 79% of the companies in the telecommunications industry. Its interest coverage ratio of 4.81 is adequate for debt service and ranks it better than 52% of its peers.
Does Verizon’s excessive debt put the dividend at risk?
Verizon’s dividend is not in imminent peril. Since its payout ratio is around 60%, the company’s abundant surplus free cash flow could be used to pay down a portion of its long-term debt. This would reduce interest expense and bolster available free cash flow.
Even with an inordinately high debt-to-equity ratio, Wall Street is confident in Verizon’s continued earnings stability. The company garnered rating upgrades in January.
Is it a buy?
Verizon’s rich yield is compelling. And if Verizon elects to apply some of its excess free cash flow to pay down a portion of the debt, the share price would respond favorably.
Verizon’s lofty 6.7% yield, backed by its ability to produce stable revenue, makes the stock a suitable addition to investors’ portfolios.