Dividend Investors Should Take Note of Telecoms

 |  Includes: BCE, CTL, FTR, T, VZ
by: YCharts

We’re big fans of dividends. In investing, there’s nothing less risky than the prospect of cold hard cash 'toot sweet'. Thus, we’re fond of telecom stocks, which are lately offering yields of 5% to 8%.

At a time when the S&P 500 is paying a measly 1.7% dividend yield and 10-year Treasury debt is paying just 3.5%, telecom dividend yields seem like manna from heaven. Usually, we’d have to trudge to the junk-bond market or dig through the weakest real estate investment trusts shares to find 5% to 8% income streams. These telecom stocks are highly liquid, large-cap and followed by dozens of analysts.

AT&T (NYSE:T) and Verizon Communications (NYSE:VZ) each have annual revenues exceeding $100 billion, well-established consumer brands and rapidly-growing mobile-phone businesses thanks to their sales of devices like Apple’s (NASDAQ:AAPL) marvelous iPhone. BCE is a big telecom provider in Canada and Frontier Communications (NASDAQ:FTR) and Qwest Communications International (NYSE:Q) are large regional providers in the U.S.

So are the dividends these outfits are paying safe, then? Some yes, some not so much.

The key thing to remember when making a dividend play is to focus very little on the dividend that a company is paying right now and instead drill in on the dividend that they could be paying a year from now. So study charts of earnings yield (earnings per share divided by stock price) versus dividend yield (dividends divided by stock price). If a company has a bad habit of paying out dividends that exceed earnings, you will see it in this chart. So depending on its dividends may be bad for your financial health.

So take Frontier. This $5 billion-in-sales outfit in Stamford, Conn., is slated to pay 75 cents a share in dividends. But if you buy its shares at a recent $9.30 each, don’t bank on the 8%-plus yield. Analysts estimate that Frontier will earn just 40 cents or so this year.

It makes no sense to pay out dividends that exceed the cash flow available for distribution. Frontier’s managers have a history of overpaying their dividend, then suspending it when things get hairy.

At the safest end of the spectrum, there’s BCE. This $19 billion-in-sales Quebec-based firm is thought likely to earn around $3 a share this year, which is about 60% more than what it needs to cover the $1.82 a share in planned dividends. Yes, like Frontier, BCE briefly suspended its dividend during the financial meltdown. But it appears to have been an act of excess prudence. Unlike Frontier’s managers, BCE prefers to pay dividends they can sustain. So the company’s earnings-yield-versus-dividend-yield chart is a thing of beauty, with the blue earnings-yield line always above the orange dividend-yield line.

Okay, but what about the big names, AT&T and Verizon? It’s mixed news. For the last five years at least, AT&T has been paying out dividends that its earnings actually support.

Verizon, less so:

But both companies’ dividends seem safe for 2011. AT&T is supposed to pay $1.72 a share in dividends, which is quite a bit less than the $2.50 a share or so that analysts think it will earn. Verizon’s $1.95-a-share dividend is less than the $2.60 in EPS that analysts are projecting.

Quest’s dividend picture, by the way, looks Verizon-esque. Its expected 40 cents per share in earnings this year should cover its 32-cent dividend. But it has indulged in paying out dividends that its earnings didn’t apparently support in the past.

So which of these shares would we sell junk bonds and REITs to buy? The sucker bet is clearly Frontier. And the underappreciated jewel is BCE, which not only has the most sustainable dividends but also is the least leveraged (41% debt-to-enterprise) of all five of these telecom outfits. BCE also has the lowest enterprise multiple (enterprise value divided by trailing 12-month EBITDA), of just over 6 times versus 8 times for AT&T, Verizon and Quest.

The most compelling of the rest is AT&T, which pays a richer dividend than Verizon or Qwest but is just 50% leveraged versus their 60% each. Go ahead and complain about AT&T’s dropped iPhone calls if you want. The company looks well positioned to continue boosting its dividends in the next few years, just as it has in the last couple of decades:

Disclosure: None