Published November 18th, 2016 by Bob Ciura
Verizon Communications (VZ) stock has declined around 15% from its 52-week high. The market appears concerned that rising interest rates will negatively impact high-yield dividend stocks like telecoms.
Verizon does have a lot of debt, after buying Verizon Wireless a few years back. But it also generates tens of billions of dollars each year in free cash flow. This allows it to pay down debt and pay a substantial dividend to shareholders.
Income investors tend to favor telecoms, because of their high dividend yields. Verizon is no exception. This stock has a nearly 5% dividend yield and the company raises its dividend regularly.
In September, Verizon increased its dividend by 2%. That was its 10th consecutive annual dividend increase. This makes Verizon a Dividend Achiever; a select group of stocks with 10+ consecutive years of dividend increases. You can see all 273 Dividend Achievers here.
Verizon is a favorite of Mr. Wonderful (for whatever that’s worth). It is one of Kevin O’Leary’s top stocks in his quality dividend ETF fund (OUSA).
With interest rates still near historic lows, Verizon’s 4.8% dividend yield could be a buying opportunity.
Verizon is a telecommunications company. It provides television, Internet, and phone service to business and residential customers.
It operates in two main businesses:
- Verizon Wireless (71% of total revenue)
- Verizon Wireline (29% of total revenue)
Verizon Wireless includes the company’s cell phone service division. This is its most important business—the wireless segment has 35.8 million device payment plan phone connections.
Wireless segment earnings before interest, taxes, depreciation, and amortization (EBITDA) margin was 44.9% last quarter, up 170 basis points year over year.
Verizon generates very high profit margins and cash flow. This is because it operates in an oligopoly. Verizon and its close competitor AT&T (T) control about two-thirds of the wireless industry in the U.S.
The reason is because there are very high barriers to entry. It would require billions of dollars to build a network that could compete on a similar scale as the two industry giants.
This provides Verizon and AT&T with what Warren Buffett would refer to as an ‘economic moat’.
As a result, Verizon has produced solid growth over the past few years.
Source: 2015 Annual Report, page 4
The biggest driver of Verizon’s huge cash flows is its wireless business.
Source: 2015 Annual Report, page 7
Verizon has invested significantly in its network, and is reaping the benefits. Verizon raked in $21 billion of free cash flow in 2015. The company allocated billions of free cash flow to shareholders. It paid $8.5 billion of dividends, and bought back $5.1 billion of its stock.
Business conditions remain very positive for Verizon. Consumers love their cell phones and have a seemingly insatiable hunger for data.
Verizon refers to its high-quality customer base as its driver of profitability.
Verizon’s customers are willing to pay higher prices for the company’s top-tier network, which fuels high margins. This is especially true on the wireless side of the business.
Verizon’s churn, which represents customers that leave for a competing service, has held below 0.90% for six consecutive quarters.
One might assume the telecom industry is saturated in the U.S. But the good news for Verizon shareholders is that the company has several tailwinds for growth at its back.
Source: Third Quarter Earnings Presentation, page 13
Among Verizon’s most important drivers of future growth are 5G, the Internet of Things (or IoT), and digital advertising.
Approximately 90% of Verizon’s traffic now resides on its 4G network. It is likely that 5G will be the next step in Verizon’s growth.
As demand for mobile video grows, so too will data requirements. 5G rollout will allow Verizon to strengthen its position as having the industry’s strongest network. This will continue to be a competitive advantage for the company.
Separately, the IoT will be a growth driver. IoT brings connected solutions to the physical environment. For example, increased connectivity at home and in automobiles.
To expand in this area, Verizon is turning to acquisitions. It acquired Telogis this year to enter the connected car market. And, Verizon acquired Fleetmatics for $2.4 billion in the same area.
Verizon’s IoT revenue increased 18% last year, and the recent acquisitions pave the way for even greater growth.
Lastly, Verizon has conducted acquisitions to build its digital advertising platform. To do this, it bought AOL for $4 billion and a collection of assets from Yahoo! (YHOO) for nearly $5 billion.
The one positive about Verizon’s share price decline is that it has elevated the dividend yield to nearly 5%. This gives investors the opportunity to earn more than double the average dividend yield of the S&P 500.
For income investors, Verizon’s falling stock price could be viewed as a buying opportunity. Even more so, because the dividend looks highly sustainable going forward.
After acquiring the rest of Verizon Wireless for $130 billion, Verizon has a lot of debt on the balance sheet. In fact, it ended last quarter with $103 billion of long-term debt.
Fortunately, its debt appears to be manageable. Verizon has $3.5 billion in long-term debt coming due over the next year. Its debt is spread out over many years.
And, since it generates such high free cash flow, it should have little trouble sustaining its dividend payments and raising its dividend modestly each year.
Last year, Verizon had earnings-per-share of $3.99 and declared dividends of $2.23 per share. This means the company distributed 56% of its earnings-per-share last year as shareholder dividends.
With a payout ratio slightly over half of annual earnings, Verizon has a comfortable dividend payout.
Going forward, investors can expect annual dividend growth that at least matches inflation. This sets investors up well for income generation. Verizon offers a high dividend yield and enough dividend growth to protect its investors’ purchasing power over time.
Investors never like to see a stock price decline. But the upside is that it elevates a stock’s dividend yield. Verizon’s share price decline in recent weeks has lifted its dividend yield up to 4.8%. Verizon is a consistently high paying dividend company with growth potential.
Income investors looking for high, sustainable dividend yields have an opportunity to scoop up Verizon and its ~5% dividend yield.