Verizon (VZ) currently offers one of the highest-yielding dividends in the S&P 500 at 7.7%. Dividend yields that high often signal that a payout is at a greater risk of being cut.

However, that’s not the case with Verizon’s payout. That was evident from the telecom giant’s third-quarter report, which shows it’s a cash-generating machine.

Widening free cash flow
Verizon has generated $28.8 billion in cash flow from operations through the first nine months of this year. That was a little more than a 2% improvement from the same period last year. However, capital spending has decreased significantly, falling from $15.8 billion to $14.2 billion. As a result, the company’s free cash flow has increased by $2.2 billion to $14.6 billion. Verizon has produced more free cash flow in the first nine months of 2023 than it did in all of 2022.

That provided the company with plenty of money to cover its dividend payouts, which have totaled $8.2 billion this year. Those payments are up from $8.1 billion in 2022 because Verizon has increased its dividend by 2% over the past year. Even with that higher outlay, Verizon’s dividend payout ratio has fallen. It was at 56% through the first nine months of this year, an improvement from 65% compared to the prior-year period.

Verizon has tallied $6.4 billion in excess free cash after paying dividends and covering its capital spending plan this year. It used that money to strengthen its already solid balance sheet. Verizon ended the quarter with a leverage ratio of 2.6, down from 2.7 in the year-ago period. That relatively low leverage ratio supports the company’s strong investment-grade bond ratings (A-/BBB+/Baa1).

With its business generating excess cash and its already solid leverage ratio falling, Verizon’s dividend is on a firm foundation.

The payout’s foundation should continue getting stronger
Verizon now expects to produce more than $18 billion in free cash flow this year. That’s $1 billion more than its previous forecast, even though capital spending will be at the upper end of its previously forecast range of $18.3 billion to $19.3 billion. That will give the company even more money to strengthen its financial foundation.

The company’s growing cash flow and healthy balance sheet gave its management team the confidence to boost its dividend again last month. That roughly 2% increase pushed its dividend-hiking streak to 17 straight years, the longest current streak in the U.S. telecom sector.

That steady upward trend should continue. The capital investments the company made to expand its network are starting to pay off. Verizon increased its broadband subscribers by nearly 21% year over year during the third quarter to 10.3 million. It also continued adding new wireless subscribers. The company’s growing subscriber base will expand its revenue and operating cash flow.

Meanwhile, Verizon expects its capital spending to fall next year to a range of $17 billion to $17.5 billion, which will free up more cash flow for it to use to further deleverage its balance sheet. It’s also working toward cutting an additional $2 billion to $3 billion in costs by 2025. Its improved free cash flow and balance sheet will give Verizon even more flexibility to continue increasing its dividend.

The company’s long-term goal remains to get its leverage ratio down to an even more conservative 2.25. Once it hits that target, it plans to return even more money to shareholders by allocating some excess free cash flow to repurchasing shares.

Everything is going according to plan
Verizon’s strategy is paying off. The company invested heavily in enhancing its network, and the results of that effort are starting to drive subscriber and revenue growth. Meanwhile, its capital spending is now returning to a more normal level, enabling it to generate a lot more free cash flow. It’s using that money to strengthen its already solid balance sheet, putting its dividend on an even firmer foundation. That makes Verizon an attractive option for investors seeking a rock-solid stream of steadily rising dividend income.

— Matthew DiLallo

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Source: The Motley Fool