How Safe Are Your Telecom Dividends?

Last week's absolute collapse of Alaska Communications (Nasdaq: ALSK  ) on news that it might cut its dividend was quite the wake-up call for investors. Back in August, I had warned that the dividend might be in trouble; though no official cuts have been made, the prospect of losing a sizable payout sent shares tumbling 28%.

With this story as a backdrop, I set out to see how safe the rest of the large dividends being paid out by domestic telecoms really are.

Metric No. 1: Payout ratio from earnings
The most frequently used way of checking on the sustainability of a dividend -- and especially the hefty ones -- is by examining a company's payout ratio. This measures the percent of a company's earnings that are used to pay shareholders their dividends.

The following table includes six more telecom stocks, their current yield, and their payout ratio.

Company

Dividend Yield

Payout Ratio

Verizon (NYSE: VZ  ) 5.3% 94%
AT&T (NYSE: T  ) 5.8% 87%
CenturyLink (NYSE: CTL  ) 7.7% 158%
Frontier Communications (NYSE: FTR  ) 13.2% 500%
Consolidated Communications (Nasdaq: CNSL  ) 8.2% 182%
Windstream (Nasdaq: WIN  ) 8.3% 192%

Source: Yahoo! Finance.

At first blush, this seems pretty bad. Only Verizon and AT&T were technically able to afford all of their dividends with the money they took in.

And the rest of them? Well, they look pretty awful.

Metric No. 2: Payout ratio from free cash flow.
But in reality, corporations don't keep track of their money the same way we did when we were in college: by the amount of cash in our pockets. Items like accounts receivable and payable, depreciation, and goodwill are included in earnings -- and they don't immediately affect the amount of money a company has in the bank.

That's the whole reason we measure free cash flow. This number is very important -- it is a tool that essentially tells us what we wanted to know back in college: how much money does this company have in its pockets (or, if they're being professional, in the bank).

Check out the free cash flow payout ratio for these companies, and the story changes considerably. These numbers show how much free cash was used to pay out dividends so far in 2011.

Company

FCF Payout Ratio

Verizon 46% 
AT&T 61% 
CenturyLink 56% 
Frontier Communications 98% 
Consolidated Communications 56% 
Windstream 93% 

Source: SEC filings.

Clearly, this changes things in a big way. All of the companies look like they have much more sustainable dividends. Verizon, AT&T, CenturyLink, and Consolidated all fall well below the 80% threshold.

Frontier and Windstream, however, seem to be in the danger zone. Several Fools have given a nuanced take on these two providers. But if you want the abbreviated version, here goes: Frontier and Windstream are heavily reliant on wired, rural customers. As the move toward mobile telephony continues, it will become harder and harder for these two to pull in the free cash flow to warrant such huge dividends.

Needless to say, if you're investing in Frontier or Windstream, do it with eyes wide open and an eye toward dividend sustainability.

The best of the rest
If you're trying to narrow down your list, looking at a company's dividend growth rate can help. AT&T and Verizon are mature stalwarts, and over the past three years, their dividends had an average growth rate of 2.4% and 3.9%, respectively. Though you always need to keep an eye out for tactical moves made by each side -- like AT&T's attempt to acquire T-Mobile -- they are relatively safe bets within the telecom space.

CenturyLink, on the other hand, shows a three-year growth rate of 28.8%, but this is largely because of a huge jump in payouts the company took in 2008, when the average quarterly dividend payout went from $0.07 to $0.70. Since then, dividend raises have taken on understandably slower growth.

And Consolidated is as steady as can be, as they have neither raised nor cut their dividend since they began offering it in 2005.

It is also interesting to note that while these domestic telecoms pride themselves on relatively stable, steady dividend pay-outs, international telecoms are far more willing to change up their dividends depending on the times. While it's probably good for a company's balance sheet, this international approach probably wouldn't be nearly as exciting for dividend investors who like to know how much their dividend checks will be each quarter.

A few more excellent dividend ideas
If you're looking for a few more dividend-paying stocks that our analysts think will have no problem sustaining their payouts, I suggest you check out our newest special free report: "Secure Your Future With 11 Rock-Solid Dividends." Inside the report, you'll get the names of stocks our analysts hand-picked for their dividend-paying fortitude. The report is yours today, absolutely free.

Fool contributor Brian Stoffel does not own shares in any of the companies mentioned. You can follow him on Twitter at @TMFStoffel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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