One of the more surprising stories in investing is the struggles of Verizon (VZ 0.85%), only one of three U.S. companies providing nationwide wireless service. One might think that oligopoly power would amount to rising profits, considering the necessity of wireless coverage in today's society.
Nonetheless, maintaining such networks comes at a tremendous cost, and the evolution of the technology means the company will probably keep spending heavily to support its business. These factors make it much harder for Verizon to maintain its current dividend over the long term.
NYSE: VZ
Key Data Points
Verizon's dividend looks desirable
On the surface, Verizon's dividend looks like one of the most desirable payouts in the S&P 500. At $2.61 per share annually, it equates to a dividend yield of around 7.2%. Moreover, the dividend has increased every year since 2007.
Companies can adjust dividend levels at any time, and many of them increase the payout annually to instill confidence in the payout. Hence, Verizon's 16 straight years of payout hikes created an expectation of another annual increase later this year.
The problem is, paying the dividend looks like a struggle and one that's growing. In 2022, $14 billion in free cash flow covered the $11 billion in dividend costs. Fortunately, free cash flow excludes capital expenditures (capex). So on the surface, it looks like Verizon could afford to cover the dividend and afford most increases to the payout.
Why the dividend became less affordable
Nonetheless, the economics of telecom stocks changed since Verizon's predecessor, Bell Atlantic, emerged from the breakup of the old AT&T in the early 1980s. In past decades, slowly evolving technology didn't necessitate heavy capital investments. Such conditions made generous, rising dividends for shareholders affordable.
That logic may not hold if you're bargain-hunting in dividend stocks. Verizon, along with AT&T and T-Mobile, each spent tens of billions of dollars toward the end of the last decade to finance an upgrade to 5G-level services. All three companies will soon have to start spending to upgrade to 6G connectivity technology in preparation for that upcoming release later in the decade. That means Verizon's capex spending, which amounted to $23 billion in 2022 alone, is unlikely to slow down.
Additionally, capex spending, along with expenditures for wireless licenses, contributed heavily to the $153 billion in total debt Verizon is juggling. That's a tremendous burden for a company claiming $94 billion in stockholders' equity. Verizon had a cost of debt of $4 billion in 2022. Now, with rising interest rates, that expense will likely increase.
Investors should also remember that T-Mobile doesn't pay a dividend, and AT&T, which once claimed a 35-year streak of consecutive dividend increases, slashed its payout last year. Since it also faces high debt levels amid a generous dividend yield, AT&T could cut the payout again.
That leaves Verizon with the only rising dividend in the industry. But given its considerable payout costs and massive debt, the company has much less incentive to maintain dividend increases amid its competitive threats.
Sell Verizon?
Considering Verizon's financials, its dividend is unlikely to survive in its current form. Should income investors sell?
Although free cash flow covered the dividend cost in 2022, the payout is in more trouble than it might otherwise appear. Verizon's huge total debt and massive capex expenses that are unlikely to slow may cause stakeholders to question the dividend's cost.
Moreover, with the company's main rivals cutting payouts or avoiding dividends altogether, the pressure to follow their lead will likely become too great. Hence, income investors should consider selling and looking for more stable dividend income streams.
