Wednesday, May 11, 2016

Verizon: A High-Yield Telecom For Current Income

Verizon Communications Inc. (NYSE:VZ) provides communications, information, and entertainment products and services to consumers, businesses, and governmental agencies worldwide. This dividend achiever has paid dividends since 1984 and increased them for 11 years in a row. Verizon ranks in The Top 10 in the Sure Dividend system. Click here to see the other Top 10 Dividend Growth Stocks

The most recent dividend increase was in September 2015, when the Board of Directors approved a 2.70% increase in the quarterly dividend to 56.50 cents/share.

The company's competitors include AT&T (NYSE:T), Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS).

Over the past decade this dividend growth stock has delivered an annualized total return of 11.50% to its shareholders. Future returns will be dependent on growth in earnings and initial dividend yields obtained by shareholders.

The company has managed to deliver a 5.10% average increase in annual EPS over the past decade. The company's annual earnings per share fluctuates wildly due to one-time accounting effects, such as pension adjustments for example. Verizon is expected to earn $3.96 per share in 2016 and $4.04 per share in 2017. In comparison, the company earned $4.37/share in 2015.

Verizon is one of the two dominant telecom players in the US, the other one being AT&T. Both companies have the scale in number of customers to compete successfully, invest in their business and market their products, while keeping costs of servicing customers low and therefore generating excess cash flows. Both companies also have some pricing power over suppliers due their scale. Those excess cash flows are returned to shareholders through a generous dividend. In addition, the company has the reputation for America's best coverage for wireless, which provides it with a high market share and customer loyalty. This has resulted in low churn rates, which in essence makes it easier to make money, since acquiring new customers is expensive. In addition, Verizon has valuable spectrum, which is of limited quantity in the US. The company participated in the 2015 Spectrum Auction, in order to gain more of this precious but limited resource.

The company has been able to grow through acquisitions over the past years, which is another way that it can bolster its future earnings per share.

On the other hand, the telecom services industry is extremely capital intensive. There are constant requirements to upgrade the network according to new standards, and to make sure that the quality is maintained at a good level for customers to enjoy.

The risk to Verizon is that the already cutthroat telecom market is shaken by a price war, and aggressive promotions to attract new customers, which could be bad for margins and profitability. Contrary to what many believe, the telecom market of today is highly competitive. It is extremely easy to switch carriers. However, Verizon and AT&T differentiate themselves by spending a lot of money on their networks

The other thing to note is that Verizon competes with cable companies in its FIOS Internet & FIOS Video services.

I like the fact that Verizon was able to acquire the remaining 45% of Verizon Wireless it didn't already own from Vodafone (NASDAQ:VOD) by paying $130 billion in cash and stock in 2013. The company took on approximately $60 billion in debt, and also offered asset stakes to Vodafone to pay up for Verizon Wireless. This deal was expected to be accretive to Verizon over time, and is helpful to have been done at a time when interest rates are so low. I own shares of Verizon, as part of this transaction where Vodafone shareholders received cash and Verizon stock as part of the deal.
It would be nice if the company takes on the challenge of repurchasing those dilutive shares over the next decade. However, it would also be important to pay off debt, in order to secure a more stable financial position for the uncertain future.

The annual dividend payment has increased by 3.30% per year over the past decade, which is lower than the growth in EPS. My expectations for future dividend growth are for them to be close to the rate of inflation over the next two decades.

A 3% growth in distributions translates into the dividend payment doubling every twenty four years on average. If we check the dividend history, going as far back as 1991, we could see that Verizon has last managed to double dividends every 25 years on average.

In the past decade, the dividend payout ratio has been all over the place. This was of course caused by the effect of one-time items on earnings per share. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently, Verizon is attractively valued at 12.80 times forward earnings, and has a dividend yield of 4.40%. In comparison, rival AT&T is selling for 13.50 times forward earnings and yields 5%. These are proverbial high yield but slow growth dividend companies, that would be a good addition in a dividend growth portfolio. Check my article on the three types of dividend stocks for a diversified portfolio.

Both Verizon and AT&T have been preferred investment vehicles to retired investors, due to their above average yields. Unfortunately, the slow dividend growth can only be expected to keep pace with inflation at best. That being said, if one needs high current income today, and would not be opposed to mostly keeping up the purchasing power of their dividend income over the next decade or two, Verizon could be the type of company to buy and hold.

Full Disclosure: Long VZ and VOD

Relevant Articles:

Types of dividend growth stocks
Should I invest in AT&T and Verizon for high dividend income?
Sector Allocations for Dividend Growth Investors
How to Increase Dividend Income
Sector Allocations for Dividend Growth Investors

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