Shares of Verizon Communications (NYSE:VZ) are now attached to a near-all-time-high dividend yield of 8.4%, following a constant decline that has persisted for more than four years. In fact, the telecom giant, which boasts 143.3 million subscribers, has seen its stock lose about half of its value since its 2019 highs. The steep stock price decline likely mirrors investors’ expectations of a dividend cut, which is a possibility, as Verizon’s debt levels have been reaching unsustainable levels. Nevertheless, I am neutral on the stock.
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Why is Verizon Stock Falling?
The ongoing, brutal decline of Verizon stock can be attributed to the intricate dynamics of its capital expenditure (CapEx)-heavy business model, particularly in the context of a rising-rates environment. As we delve into the reasons behind this decline, a crucial aspect comes to light — the risk CapEx poses to Verizon’s dividend, a factor that has been making the stock less enticing for investors.
Verizon’s CapEx-Intensive Business Model
Verizon’s operational structure demands a continuous influx of CapEx, primarily driven by the nature of the telecommunications industry. The company manages an extensive network infrastructure comprising cellular towers, fiber optic cables, data centers, and other critical components that require constant maintenance. To remain competitive, Verizon must consistently expand and upgrade this infrastructure to service the surging demand for data and offer the latest technologies like 5G.
How Does Verizon Fund Its CapEx?
To meet these demands, Verizon faces the challenge of funding its CapEx, a task that is quite problematic because of the allocation of significant operating cash flows to dividend payments and debt reduction.
The solution? The company turns to the debt markets to secure the additional funds required for these essential investments. The numbers tell a story of a lack of sustainability. Specifically, Verizon’s CapEx increased from $16.6 billion in 2013 to $22.7 billion in the past four quarters. In the meantime, operating cash flows have declined from $38.8 billion to $37.5 billion during the equivalent periods. You can now see the roots of the impending problem.
Rising Debt and Its Implications
The combination of growing CapEx and dividends against stagnated operating cash flows has led to Verizon taking on massive amounts of debt. In particular, its total debt has soared from around $50 billion a decade ago to a staggering $182.3 billion in its most recent quarterly report.
While this was historically manageable due to low interest rates, the rising interest rate environment poses a new challenge. As Verizon gradually refinances its debt, the cost of debt is expected to surge. This will likely impact free cash flow and, consequently, the viability of its dividend.
To quantify this concern, consensus estimates predict Verizon’s interest expenses to surpass $5.0 billion and $6 billion in Fiscal 2024 and Fiscal 2025, respectively. These are massive leaps from last year’s interest expenses of $3.61 billion.
This trend raises concerns among investors regarding Verizon’s ability to meet all of its financial obligations while also rewarding shareholders. As a result, the once-reliable dividend faces a precarious future, contributing to the unease surrounding Verizon stock.
Verizon’s 8.4% Yield Reflects Dividend Cut Expectations
In my view, the recent trend of investors offloading their Verizon shares, resulting in a notable uptick in its dividend yield to 8.4%, serves as a clear reflection of the growing anticipation for an imminent dividend reduction. Effectively, investors are presently valuing the stock with an eye on subpar future capital returns—an anticipation that aligns with the looming prospect of a dividend cut. Given the anticipated escalation in interest expenses over the next few years, such a scenario seems quite likely.
Even if the company could technically sustain the current dividend, the prospect of allocating substantial resources to servicing debt, compared to expedited deleveraging through a dividend reduction, would prove detrimental to shareholder value. Consequently, one should not be misled by the seemingly adequate payout ratio for Verizon. Times have evolved, and so too must the company’s strategic priorities.
It’s worth noting that a similar situation unfolded with AT&T (NYSE:T), another telecommunications giant, which found itself compelled to trim its dividend in the first quarter of the previous year, as total debt had reached an astonishing $237.6 billion. Since then, the company has successfully managed to reduce its total debt to a more “manageable” $168.7 billion.
Is VZ Stock a Buy, According to Analysts?
Turning to Wall Street, Verizon Communications has a Moderate Buy consensus rating based on four Buys and nine Holds assigned in the past three months. At $39.45, the average Verizon Communications stock forecast implies 25.4% upside potential.
The Takeaway
Overall, Verizon’s ongoing share price decline, driven by a capital-intensive business model and soaring debt, has raised concerns about its generous dividend. The company’s reliance on debt to fund essential investments, coupled with rising interest rates, threatens the sustainability of its payouts.
With aggressive deleveraging most likely being the most shareholder-friendly move at this point, it’s no wonder investors are bracing for a dividend cut. While I am neutral on the stock, given that shares have cratered already, it seems prudent not to depend on Verizon’s dividend for income.
