One thing that attracts many investors to telecom stocks are the great dividend yields offered by many companies in the industry. Subscription revenue and long-term contracts are a great recipe for predictable free cash flow. And many of the biggest companies in the industry are happy to return that cash to shareholders.
Verizon Communications (NYSE: VZ), for example, paid out $11.2 billion to shareholders over the last 12 months. The stock currently boasts an attractive dividend yield of 6.6%. AT&T (NYSE: T) has slimmed down over the past few years, now focusing exclusively on its telecom business. It sports a 5% dividend yield, paying out $8.2 billion to shareholders over the past year.
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But one of its biggest competitors has returned even more cash to shareholders. T-Mobile (NASDAQ: TMUS) returned a total of $11.8 billion over the past year. The only caveat is this telecom giant is primarily using share repurchases in its capital-return program, something that’s practically non-existent recently at Verizon and AT&T.
Over time, however, T-Mobile could shift that focus to dividends. In fact, management just announced a 35% increase to its dividend payout, bringing its yield to a healthy 1.6%. T-Mobile’s massive capital-return program could prove even better for shareholders than big cash dividends from its competition.
There are really only two ways for management to return excess cash to shareholders: share repurchases and dividends.
Dividends are straightforward: The company pays owners a set amount of cash per share, usually on a regular cadence like every quarter. While management isn’t obligated to pay out the same amount every period, dividends are generally very sticky. Once a company starts paying a certain amount, they try to keep paying at least that much. Often, a company will raise its dividend over time. Verizon has increased its dividend annually for 18 straight years.
Share repurchases, on the other hand, are an indirect way to return cash to shareholders. Instead of distributing cash, management uses it to buy shares of the stock in private deals or on the open market. The shareholders end up with a greater share of the business.
Another way to think of it is shareholders receive equity in the business instead of cash. It’s almost the same as a shareholder who automatically reinvests dividends into the stock. However, there’s much less of a tax drag on the transaction. Share repurchases incur a 1% tax (paid by the business); qualified dividends are taxed at the long-term capital gains tax rate (paid by the shareholder).
Thus, returning capital to shareholders through share repurchases can be a much more effective way to create shareholder value than a dividend. So, investors shouldn’t write off T-Mobile’s massive capital returns over the past year just because it focuses on repurchases instead of dividends. For long-term investors, T-Mobile’s ability to reduce its share count today will increase the potential dividend it pays in the future.
It’s one thing for a company to reduce its cash on its balance sheet in a one-time spike in capital returns, but another for it to consistently return more and more cash to shareholders.
Management expects to generate about $80 billion in additional capacity for investments and shareholder returns through 2027 by maintaining its current leverage ratio and growing its earnings before interest, taxes, depreciation, and amortization (EBITDA). It’s already earmarked $10 billion for existing transactions but expects to return $50 billion of that to shareholders. That’s an average of more than $15 billion per year at the time management made the announcement at its investor day at the end of the third quarter. It’s also leaving $20 billion for additional investments or acquisitions, but some of that could end up in the capital-return program as well.
The vast majority of those capital returns will come in the form of share repurchases, but investors should expect steady dividend growth as well. As mentioned, management already announced a 35% increase to the dividend in September. Still, that will only amount to about $4 billion total over the next year.
Management is targeting a mid-20% portion of free cash flow for its dividend. Its 2027 outlook calls for $18.5 billion in free cash flow, which means investors should expect about $4.6 billion in total dividend payments that year. Combined with the aggressive share repurchases, investors can reasonably expect annual raises of about 10% in each of the next two years based on management’s comments.
T-Mobile has two advantages over AT&T and Verizon in its ability to generate and return cash to shareholders. First, it’s not as levered as either competitor. Both AT&T and Verizon made debt-financed acquisitions over the last decade that failed to add value for shareholders but left them with a lot of debt. They’re still working to pay down debt, which eats up a lot of cash flow.
Additionally, T-Mobile has an advantageous spectrum portfolio, which allows it to be more selective and cost-conscious when it comes to new spectrum-license auctions. It’s also taken a different strategy when it comes to fiber, opting to lease fixed-line assets. That saves it money in terms of capital expenditures but comes with ongoing costs. T-Mobile could change its strategy in the future, which might eat into that $20 billion buffer from its long-term outlook.
There’s no denying investors will have to pay a premium for T-Mobile stock versus AT&T or Verizon. The shares trade for an enterprise value-to-EBITDA ratio of 11. That’s well above AT&T (7.3) and Verizon (8.2).
That said, T-Mobile expects EBITDA to grow at an annual rate of 7% between 2023 and 2027, more than three times faster than either AT&T or Verizon. That’s driven by share gains, as T-Mobile remains the fastest-growing wireless provider in the country. T-Mobile also expects to improve its margin on its service revenue, with a focus on free-cash-flow conversion. It’s targeting 25% free-cash-flow conversion by 2027, up from 21% in 2023.
Faster growth and expanding margin should support a much higher multiple than its peers. With the massive share-repurchase program bolstering the value of future earnings for each remaining share, the stock looks fairly valued.
Investors interested in a company that aims to return steady and growing cash flows to shareholders in the most effective way possible should take a closer look at T-Mobile.
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Adam Levy has no position in any of the stocks mentioned. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.
This Unstoppable Telecom Giant Returned More Capital to Shareholders Than Both AT&T and Verizon Over the Past Year, and It Just Raised Its Dividend 35% was originally published by The Motley Fool
Source: finance.yahoo.com