Verizon (VZ -0.86%) pays one of the biggest dividends in the S&P 500. The telecom giant currently yields 6.5%. That's one of the top 10 payouts in the index and well above the S&P 500's 1.6% dividend yield.
The company generates plenty of cash flow to cover its big-time dividend payment and capital expenses with room to spare. However, its payout hangs on one factor: The health of the consumer. It's a risk that investors need to understand if they're buying Verizon for its high-yield dividend.
How Verizon makes money
Verizon is one of the world's largest communication-technology companies. It offers voice, data, and video services and solutions to millions of customers.
However, the telecom company gets the bulk of its revenue and growth from its consumer segment:
As that graphic showcases, Verizon's consumer segment contributed the bulk of its revenue (77%) during the fourth quarter. The company generates this revenue from providing wireless services (post- and pre-paid) and wireline services (i.e., Fios internet and video) to millions of customers.
Verizon had 114.5 million wireless retail connections and 7.9 million broadband connections (including 6.7 million Fios Internet connections). It also generates revenue by selling or leasing equipment to consumers (e.g., mobile phones and modems).
While the company also collects lots of revenue by providing wireless and wireline services to businesses and government entities, it pales in comparison to its consumer segment. In addition, business revenue is growing much slower. It's also much less profitable. (Verizon's consumer operating income margin is in the upper 20% range, while business operating income margin is in the high single digits.)
Because of all that, Verizon has a lot riding on the health of the consumer.
Why Verizon's consumer focus could prove problematic for its dividend
Verizon provides vital communications services to consumers. We're increasingly reliant on our mobile devices and internet access. Because of that, Verizon generates lots of recurring cash flow by providing wireless and wireline services to consumers.
However, consumers are more likely to stop paying their cellphone bills or switch to a lower-cost provider if they experience financial trouble, which can occur during an economic downturn. Because of that, the revenue source is less secure than that from a large business or government customer. We can see that in a higher churn rate, which is the rate customers stop doing business with an entity.
For example, the wireless churn rate in the consumer segment rose from 1.1% to 1.63% from 2021 to 2022 as economic conditions weakened. Contrast that with the relatively lower and steadier churn rate of business customers (1.07% in 2022 and 1.03% in 2021).
If the economy becomes materially weaker, Verizon's retail churn rate could rise even further, cutting into its revenue, earnings, and cash flow. If a deep economic downturn hits consumers hard, Verizon may feel the pinch, which could impact its ability to maintain its big-time dividend.
Focused on what makes the most money
In the past, Verizon has tried to reduce its reliance on consumers by diversifying its business. It once bought former internet darlings AOL and Yahoo, paying over $8.9 billion for the media properties. Unfortunately, that strategy failed miserably, as Verizon eventually sold its entire media business to a private equity fund for $5 billion.
The company has found that it can make a lot of money by focusing on what it does well -- providing communication technology services. That's leading Verizon to continue investing in enhancing that business, spending billions of dollars on building its 5G network.
The telecom company believes this strategy will pay dividends over the long term by enabling it to generate more revenue per user. It should allow the company to grow its cash flow -- assuming there isn't a deep recession -- which should empower it to continue growing its dividend.
Verizon currently has the longest consecutive streak of dividend growth in the U.S. telecom sector at 16 years. While the company's consumer concentration is a risk, income-focused investors should only avoid the stock if they're really worried about a potentially deep recession.
