At the recent share price, Verizon's (VZ -0.54%) dividend pays investors a generous yield of 6.1%. While AT&T's (T -1.34%) yield is slightly higher, the spinoff of its ill-fated WarnerMedia acquisition (which was merged then with Discovery to create Warner Bros. Discovery) led to an effective dividend cut earlier in the year. The last of the big three U.S. cell providers, T-Mobile US (TMUS 0.17%), doesn't pay a dividend at all.
So if you are an income investor, Verizon may look like your best choice in the mobile telecom space. Here's one reason why the telecom giant is a good option and one reason why investors should be concerned.
Green flag: The biggest and best?
Verizon likes to tout the fact that in 2022, J.D. Power named it "the Most Awarded Brand for Wireless Network Quality for the 29th consecutive time." That's a big selling point for cell customers who want to make sure they can make and receive calls and text messages and connect to the internet wherever they may be.
It helps explain why Verizon has some 91.5 million postpaid subscribers. For comparison, AT&T has 82.7 million and T-Mobile US has nearly 71.1 million.
In many ways, being bigger is better when it comes to cellphone service. Spreading a network's costs over more users improves profitability. Notably, Verizon's operating margins have historically been higher than those of its closest peers. Moreover, all three of these companies track churn (basically, subscriber turnover), but those numbers are uniformly low (think low single-digit percentages or even less).
So all of their customers tend to be pretty sticky, which means Verizon isn't likely to see material declines in its subscriber base unless an aggressive market share war takes shape. But that would likely be bad for everyone involved, not just Verizon, so the probability of that happening is low.
That's more good news for income-focused investors. Notably, Verizon has increased its dividend annually for over 10 years, making it a Dividend Achiever. And with a payout ratio averaging around 50%, those dividends look fairly secure.
Red flag: The subtle issue of debt
So far, so good. But there's one fact that none of the cell service providers can escape. They all operate in a capital-intensive industry. It costs a lot of money to build and maintain a good cellphone network. Verizon's many J.D. Power awards do, indeed, have a cost. For example, each of these companies is still working toward moving customers over from 4G networks to faster 5G networks. Major technology build-outs support these efforts.
That's why it is important to keep in mind that Verizon's debt-to-equity ratio -- a measure of its leverage -- sits at 1.7. That's materially higher than AT&T's ratio of nearly 1.2 and T-Mobile's roughly 1.0 ratio. To be fair, Verizon covers its interest costs by a wider margin than either of its peers, so there's no particular reason to worry about the debt it is carrying right now.
However, you can only leverage up a balance sheet so far before lenders and other investors start to balk. That's true even for a company that's covering its interest costs, because leverage limits financial flexibility when times invariably get tough.
In Verizon's case, it also means that future spending could be more problematic since there's potentially less room for it to take on additional debt. Often the spending in this industry has to take place before material revenue start to flow in, since you can't sell services that you don't have the ability to provide.
This isn't an issue right now, per se, but it is one that dividend investors should keep in the back of their minds if they decide to pick up shares.
Not a bad dividend stock, but...
Noted above was AT&T's recent spinoff and dividend cut, which were related to a strategic misstep -- the company tried, and clearly failed, to build a thriving content business. Verizon made a similar move that backfired, but it just managed to handle it better since it didn't involve such a huge acquisition. But Verizon isn't exactly immune to management mistakes.
That said, its strong core business and commitment to its dividend clearly stand out. And, given the company's impressive customer base, it should have little problem covering its current dividend. Income investors would not be making a mistake if they chose to buy it over its main rivals.
But don't forget the leverage Verizon is carrying in a capital-intensive industry. It's not a problem right now, but that doesn't mean it won't become one later. Even Verizon bulls will want to keep tabs on the company's balance sheet.
