Verizon (NYSE:VZ) was incorporated in 1983 under the original name of Bell Atlantic when the government broke up the old AT&T (NYSE:T). Through numerous mergers and acquisitions, its name changed to Verizon, which is now one of the largest telecommunications companies in the world. The new AT&T — put together by re-merging several old subsidiaries — now competes with its offspring in wireless and other services.
The issue with many such telecoms in the U.S. is their wireline business, which is largely unnecessary for many consumers who choose to have only cell phones. This is resulting in a slow shrinkage of active wireline accounts. Verizon has decided to counter the trend by installing optical lines in many locations with the ability to carry fast Internet, TV and wireline service in the same package.
The good thing is that domestic wireless accounted for approximately 60% of Verizon’s revenues. With the popularity of smartphones and increased data usage, wireless revenues tend to show healthy growth. The mix of wireless and wireline conflicts has resulted in year-over-year overall revenue growth in the latest quarter of only 5.4%. This is perfectly fine for dividend investors because Verizon’s cash-generating ability allows for a 5.2% dividend yield, which currently shows a deceptive payout ratio of 94%.
It would be alarming in most cases to see a long period of payouts over 100% because it would simply be unsustainable, but in this case it’s the cash-generating ability that matters, not the level of earnings. Telecom companies tend to have large depreciation charges that are noncash in nature, so their earnings can be much lower than the cash they generate — and the payout ratio may not be as relevant.
Verizon produced $29.76 billion in operating cash flow in the past year — with $14.66 billion of it being levered free (this is important due to the large amount of bonds outstanding). Still, at the end of FY2010, it produced “only” $2.55 billion in net income, the bulk of which it paid out as dividends.
Another way to think about this matter is that Verizon has a lot more cash than it reports as earnings, so the volatility of the net income line doesn’t affect the dividend nearly as much as it may look when just considering the payout ratio.
