Boasting an annual dividend yield of nearly 4.5% as of Thursday, Verizon Communications (VZ 0.11%) has been a cash cow for income investors. Through its wireless voice and data services, various Internet services, and other multimedia offerings, Verizon has created a tech and telecom empire valued over $200 billion, putting it in the top 20 largest corporations in the world.
Along with that growth, Verizon has increased its quarterly dividend about 3% annually for the past five years. Despite this impressive return for its shareholders, shrewd investors know that past performance does not guarantee future results. Can Verizon keep growing its annual dividend, or will the company have to halt its growth?
Can Verizon keep the cash spigot running?
In analyzing dividend payers, I like to start with a company's sustainable growth rate, or SGR. The SGR allows investors to analyze Verizon's capacity to both pay and grow its dividend and can be calculated as follows:
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Profitability by Return on Equity (ROE) X Earnings Retention Rate | = | Sustainable Growth Rate |
Source: Chart by author
Verizon's retention rate (or the percentage of earnings per share a company retains rather than paying out in dividends) can be calculated by simply subtracting the payout percentage from 100. In the last trailing 12-month period, that was about 87%, leaving an earnings retention rate of 13%. According to the company's last earnings report for the quarter ending March 31, 2015 , Verizon's return on equity (a company's net income divided by the amount shareholders have invested) was 37.65% in the trailing 12-month period. Plugging the numbers into the equation gives us the following sustainable growth rate:
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37.65% (ROE) X 13% Earnings Retention Rate | = | Sustainable Growth Rate of 4.9% |
Source: Chart by author
This means Verizon's growth in earnings, using these metrics, was just shy of 5%; that is a modest, though respectable, number going forward. This metric suggests that future dividend increases will probably be meager (less than 5%) but sustainable at current levels. A dividend cut should be unlikely barring a substantial change in the business. Now let's add a few more pieces of data to the conversation.
Liquidity challenges
Cash is king. You need it to grow a business. As a large corporation, assets and leverage are king. Assets and liabilities are a key measure to determine a company's ability to expand operations, innovate to stay relevant with consumers, and cover expenses incurred. Let's look at some liquidity (for measuring short-term strength) and solvency (for measuring long-term strength) ratios for Verizon to see how the company is faring as far as assets and liabilities go.
For liquidity measures, I like the quick ratio because it measures short-term strength and ability to meet current obligations:
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Cash + Short-term Assets + Receivables Current Liabilities | = | Quick Ratio |
Source: Chart by author
A quick ratio of 1.0 means a company's short-term assets equally match short-term liabilities. The higher the ratio, the more short-term liquidity a company holds. Verizon's ratio currently sits at 1.01, signifying an almost equal match of cash to liabilities.
Moving beyond the immediate future tells a different story. For longer-term solvency, let's use the simple debt-to-equity ratio (a measure of longer-term strength, ability for the business to grow, and to meet debt obligations):
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Long-term Debt Equity | = | Debt-to-Equity Ratio |
Source: Chart by author
As with the quick ratio, 1.0 means long-term debt matches a company's equity. A higher number signifies a higher amount of debt leverage to finance operations, while a number lower than 1.0 indicates a higher amount of equity financing and lower debt. Verizon's debt-to-equity ratio sits at 8.99, which suggests a large amount of long-term leverage, indeed.
Putting the pieces together
With a stable business and healthy short-term cash flow, Verizon is not much of a credit risk, but the company's future growth could be hampered by the substantial burden of long-term debt. The recent acquisition of AOL (NYSE: AOL) and their various online business operations for over $4 billion was an attempt to keep pace with the increasing mobility of communication and entertainment , not an actual attempt at growth. Add to this the high-profile deal with Vodafone (VOD 0.41%) that was finalized in the first quarter of 2014 (and cost Verizon $60 billion in new debt and a total bill of about $120 billion) when Verizon bought back Vodafone's 45% stake in Verizon Wireless.. As a result, the sprawling Verizon telecom empire appears to be pigeonholed in a mature U.S. market, with minimal exposure to the expanding international scene. Throw in ample amounts of debt, and this adds up to a stagnant, albeit stable, business model.
Key takeaways
To answer the questions posed at the outset of this article, investors should expect a sustainable status quo when it comes to Verizon's dividend. Think stability, not growth. Whereas income investors might be pleased to hold Verizon in their portfolios, I'd suggest balancing out any holdings with other dividend payers that could offer a bit more growth. On the other hand, pure growth investors should probably look elsewhere for more promising stocks. Meager dividend increases and a mature U.S. telecom industry are not likely to play a large part in any stock appreciation.
