Against the backdrop of a possible interest rate hike, market participants are closely watching dividend aristocrats. In this series, we’ll see which companies are in a good position to maintain their dividend records, and which are not. We’ll also explore how companies engaging in frequent share buybacks are often attempting to enhance their earnings artificially, as compared to dividend payers that just show you the money.
Verizon (VZ) is a leading provider of wireline, wireless communications, print and on-line directory information. Wireless and Wireline are Verizon’s reportable segments. By comparison, AT&T (T) is a provider of telecommunications and digital entertainment services. Business Solutions, Entertainment Group, Consumer Mobility, and International, are its reportable segments.
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Verizon recorded a dip of 3.6 percentage points in its 2016 operating margin on a YoY (year-over-year) basis. The decline was due to an increase in operating costs and a decrease in revenue from its reportable segments. The company’s operating income had widely fluctuated over the past five years for the same reasons. This boiled down to a lower net margin, which dipped by 3.2 percentage points in 2016
Verizon’s lower income translated into lower operating cash flows, ultimately leading to lower free cash flow, and so Verizon did not generate enough free cash flow in 2016 to honor its dividend obligation. The company did not initiate any share buybacks in 2016 either. Notably, Verizon has recorded a CAGR (compound annual growth rate) of 3% in dividend per share over the past five years and has recorded an annualized dividend yield of 4.6%. Verizon (VOX) (FCOM) (IXP) has a forward PE (price-to-earnings) ratio of 12.5x.
AT&T’s operating income has also recorded fluctuations over the past five years, driven by slower growth in revenues as compared to operating costs. AT&T recorded a drop of 2 percentage points and 1.2 percentage points in its operating and net margins, respectively, in 2016. But AT&T has done share buybacks every year for the past four years, and it has generated enough free cash flow to honor its dividend obligations in each of the past four years.
AT&T has also recorded consistent growth in dividends since 2003, reporting a CAGR of 2% in dividend per share over the past five years. AT&T has recorded an annualized dividend yield of 4.6% and has a forward PE ratio of ~14x.
Relatively small players like T-Mobile US and Sprint have intensified the competition among the wireless carriers with unlimited data plans. For this reason, Verizon had to reintroduce its free data plan on February 14, 2017, to survive the competition. Verizon’s positive segment revenue and earnings, strategic acquisitions, and wireless and wireline additions are expected to drive earnings going forward. Verizon’s 1Q17 dividend per share grew 2.2% YoY.
AT&T’s positive segment revenue and earnings, growth in its wireless and wireline, strategic acquisitions and a free-cash-flow-to-dividend ratio of 70% in 2016 will all play major roles in sustaining the dividend payout of the company. In 1Q17, AT&T recorded a YoY growth of 2.1% in its dividend per share.
What’s the takeaway? In a nutshell, AT&T’s stronger free cash flow position as compared to Verizon’s could very likely make it an attractive destination for dividend-chasing investors in 2017.