Just the thought of
getting into the wireless telecommunications sector – as Bloomberg reported on June 2 – was enough to send shares of
tumbling. It also sent their dividend yields to mouth-watering levels. Their yields are about as attractive as they’ve ever been, as long as those dividends are safe.
Well, are they? Wolfe Research chief investment strategist Chris Senyek has a three-pronged test for finding dividends that are too good to be true. First, a company that pays out 80% or more of its net income may have too much money to support payments. Second, it applies the same test to free cash flow. Third, companies with a debt-to-earnings before interest, tax, depreciation and amortization, or Ebitda, ratio north of 3.5 times could also be problematic.
If two of these three criteria are met, Senyek worries about the cuts.
For most companies in
this is not a problem. The average dividend payout to free cash flow is around 40%, while the average dividend payout to net income is around 45%. The average ratio of debt to EBITDA – excluding financials, which have very different balance sheets and results – is less than twice.
And that shouldn’t be a problem for Verizon (ticker: VZ) or AT&T (T), even though the cellphone carriers have a lot of debt. AT&T’s net debt to estimated 2023 Ebitda is approximately three times, while dividends paid represent approximately 50% of estimated 2023 free cash flow and net income. Verizon is about the same as AT&T, while dividends are about 65% of estimated 2023 free cash flow and about 55% of estimated net income. These measurements are a bit higher than AT&T’s, but are not in the danger zone.
Additionally, both management teams have recently recognized the importance of dividends to their investors, at least before Amazon Wireless’ potential unfolds. The idea of Amazon as a disruptor is not new. The company always seems to be the one involved in conversations about existential threats to Incumbents. Amazon (AMZN) leases planes? It sounds the end of
(FDX). A redesigned Amazon business website? It’s the end of industrial distribution
(GWW). An Amazon Pharmacy Benefits Manager? The bottom goes
Why investors have put Amazon in these discussions is easy to understand. The company is huge, with a market cap of $1.3 trillion, about five times the combined cap of AT&T and Verizon. Also, Amazon doesn’t seem to care about low profit margins in exchange for growth, and neither does the market.
The idea of a new competitor agreeing to lower margins sounds a bit concerning, but it probably won’t happen. “Where shall we start?” Moffett Nathanson analyst Craig Moffett asked in a Friday report. There are regulatory hurdles and Amazon would have to license an existing network. The economics of a licensing deal sounds terrible for both Amazon and a wireless partner, he writes, adding that “letting the fox into the coop would be a bad idea.” Similar sentiments were expressed by Goldman Sachs, UBS and Wolfe Research. An Amazon spokesperson also said Barrons that the company has no plans to add wireless service at this time.
Although the risk of something material happening seems low, an Amazon overhang may remain for AT&T and Verizon stocks. This should suit yield-hungry investors. The Amazon Wireless report sent Verizon’s dividend yield to the highest level in some 40 years and both stocks are now yielding more than 7%, based on the annualization of current quarterly payments.
Not all businesses are meant to be disrupted. Now, dividend-focused investors can be paid to wait for everyone to notice.
Write to Al Root at email@example.com