The telecommunications industry is full of large dividend payers that consistently raise their payouts every year. But one of the industry’s newest dividend payers makes the case that it could be the best bet for long-term dividend investors.
T-Mobile (NASDAQ: TMUS) paid dividends at the end of September. A year later, they announced their first dividend increase – and it was a big one. Shareholders will receive $0.88 per share each quarter starting in December, 35% of T-Mobile’s original dividend. What’s more, management promises double dividend growth for years to come.
Here’s why T-Mobile may be the best dividend stock among the telecom giants.
It’s all about cash flow
Since completing its merger with Sprint in 2020, T-Mobile has generated substantial free cash flow for shareholders. Free cash flow rose from $3.2 billion that year to $13.6 billion last year. Over the next three years, management expects free cash flow to rise to between $18 billion and $19 billion.
For reference, T-Mobile’s biggest competitor, AT&T and Verizongenerated free cash flow of $16.8 billion and $18.7 billion, respectively, last year. Both expect to maintain the same level of free cash flow this year.
T-Mobile has been able to increase free cash flow to a level that approaches more established competitors with consistent execution above original guidance. For example, management delivered more than $8 billion in merger synergies since combining Sprint, surpassing the $7.5 billion target given in 2021. It also completed network integration a year earlier than planned.
T-Mobile’s spectrum portfolio ensures that it can bid more strategically in FCC auctions for additional bands, which means it doesn’t have to pay exorbitant prices for new radio waves. As such, it can focus its capital investment on building a 5G network, which remains ahead of AT&T and Verizon in terms of coverage.
One area where T-Mobile hasn’t invested as much as AT&T and Verizon has is fixed-line assets. It shows interest in the area, and partnered with Metronet and Lumos to take advantage of their fiber assets. T-Mobile’s model of leasing most of its fixed assets keeps capital costs down, but there are ongoing costs.
That said, T-Mobile has shown a possible strategy. The wireless customer base has been growing faster than the competition, and the home internet customer base is growing faster than competitors combined. It is currently targeting 12 million home internet customers by 2027, mainly using the additional capacity of the 5G network. Strong conversion results from service revenue to free cash.
T-Mobile plans to return most of that free cash flow to shareholders.
How can dividends continue to grow?
In its investor day, Management said it expects to generate $80 billion in “cumulative cash flexibility” between now and 2027. $50 billion is earmarked for T-Mobile’s capital return program, which consists mainly of stock repurchases.
T-Mobile’s dividend remains a small part of its return on capital. During the first year of the dividend, T-Mobile paid out a total of $3 billion to shareholders in cash. Even with a 35% increase, T-Mobile will only pay about $4 billion over the next year.
As T-Mobile uses a lot of additional capacity to buy back shares, it increases its ability to raise dividends in the future. With fewer shares to pay dividends, it has more money per share to pay out.
Management says it is targeting a mid-20% share of free cash flow for dividends. So, if the free cash flow is about $18.5 billion in 2027, this is a dividend payment of about $4.6 billion. This will translate to approximately 10% dividend increases in each of the next two years as management aggressively reduces its share count.
Management also notes that there is an additional $20 billion in the budget, which can be used for strategic investments or acquisitions. But if there are additional funds left, the shareholder return program will be the beneficiary.
Importantly, there is plenty of room for T-Mobile to increase its dividend as a percentage of free cash flow over time, since cash flow is very predictable in the industry. AT&T and Verizon paid 48% and 59% of free cash flow in dividends last year, respectively.
T-Mobile’s stock is priced at a premium to AT&T and Verizon. The enterprise value (EV)-to-EBITDA ratio of 12 is higher than AT&T (6.8) and Verizon (8.8). But with strong EBITDA and free cash flow growth on the horizon, T-Mobile is worth a premium price. At the current stock price, T-Mobile’s 1.7% yield may not seem like much compared to older telecom giants, but the potential for total returns from share repurchases and dividend growth over time is great for patient investors.
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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 Telecom Giant Just Raised Its Dividend 35%, and Promises More Double-Digit Increases to Come was originally published by The Motley Fool
