Unfortunately, this increase in spending has reduced the company’s free cash flow, potentially putting its dividend at risk.
But, despite the significant investments plowed into its 5G network, the enterprise has yet to realize similarly meaningful improvements to its balance sheet. As such, the sustainability of Verizon’s distribution has become a concern for market participants.
Therefore, we will delve into the ramifications of Verizon’s capital planning decisions, examining the potential impact on its shareholder payout as well as the business’s long-term financial viability.
A Good Quarter Only Spoiled By Bad Guidance
Verizon posted pretty solid numbers during its fourth-quarter earnings call in January, with the company achieving a noteworthy revenue beat to bring in $35.3 billion in sales, while its non-GAAP EPS of $1.19 was in-line with prior Wall Street estimates.
Moreover, the firm recorded a 23.2% increase in its 2022 retail postpaid net additions, and had its “best total broadband performance in over a decade,” with Verizon’s Fios bundled internet access and television service enjoying especially strong demand.
However, despite the optimism surrounding the brand’s switch to its next-generation mobile network, the company’s guidance of just 2.5% to 4.5% revenue growth in its Total Wireless service for 2023 proved underwhelming. Indeed, this contrasts with the 8.6% increase Verizon witnessed between 2021 and 2022, demonstrating that its board of directors is short on confidence going forward right now.
And while all that might seem bad enough, there are other challenges too. The telecommunications industry is renowned for its high capital expenditure requirements, with a variety of segments and verticals needing investment and financing from businesses in the space.
For example, the acquisition of spectrum licenses is a crucial aspect of any telco company’s operations, with demand for frequency leading to a highly competitive and costly bidding process. Indeed, Verizon had to ringfence $10 billion for its 5G rollout in 2021, with $6.2 billion spent on “C-band-related investments” in 2022 alone.
Moreover, the deployment of fiber-to-the-home networks – which provide the backbone for high-speed internet services – is another major cash drain. Not only that, the rapid evolution of technology – and the need to stay ahead of the curve – has led to significant investments in upgrading fixed wireless access too.
On top of that, the operational complexity of the sector is a major factor impacting capital resource spending as well. Hence, to ensure a top-notch level of quality and reliability, businesses must continuously invest in network management and maintenance.
This, in turn, drives up costs, requiring additional investment to meet consumer expectations. Furthermore, the fragmented nature of decision-making in the industry adds another layer of complication, with multiple stakeholders and regulators affecting CapEx decisions.
The result of having to have so much ready cash to fund these endeavors means that debt financing ultimately plays a role in enabling companies to smooth out their operations. In fact, by leveraging debt financing, firms can take advantage of the lower cost of capital and spread the costs associated with their investments over time.
However, it doesn’t always work out quite like that. In fact, Verizon’s net unsecured debt to adjusted EBITDA ratio expanded from 2.0 times in 2020 to 2.7 times at the end of the fourth quarter of 2022. This is indicative of a business that’s losing a grip on its capital allocation model, with a ratio that’s now so high that it’s close to constituting a red flag warning.
Even more concerning, however, is the fact that in the fourth quarter, Verizon had to admit that it had incurred an additional $400 million of interest expense. That said, the firm believes that it’s insulated somewhat from inflationary and interest rate headwinds due to the quality of its consumer base.
Can Verizon Still Afford Its High Dividend Yield?
A payout ratio is a key performance metric used by investors to assess the sustainability of a given company’s dividend policy. It measures the proportion of earnings paid out as dividends to shareholders, providing insight into the firm’s ability to fund its dividend obligations. A low payout fraction is desirable as it implies that a company has a strong capacity to fund its dividend and has a cushion to absorb any unforeseen bumps in the road.
In the case of Verizon, its payout ratio – based on a free cash flow calculation – has seen a material increase from 54% in 2021 to 77% in 2022. Indeed, in 2021, VZ paid out $10.4 billion in dividends from FCF of $19.3 billion, while in 2022, it paid out $10.8 billion in dividends from FCF of just $14.1 billion.
This rising payout multiple highlights the firm’s increased reliance on its free cash flow to fund its dividend payments, leaving it with a thinner margin of error should Verizon’s business conditions deteriorate.
Furthermore, a payout ratio above 70% is deemed elevated by industry standards – and may pose a risk to the sustainability of the company’s dividend policy.
What Is The Highest Paying Dividend Stock In The Dow: Conclusion
Verizon boasts a 6.4%-yielding dividend that appeals to income-seeking investors of all stripes.
However, the rising cost of its distribution should raise alarms about the company’s ability to sustain its current dividend rate, especially at a time when its earnings are also on the wane.
Nevertheless, VZ plans to scale back its CapEx in the next twelve months, which should help alleviate its cash flow problem and secure its payout in the near term at least.
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