I’ve been gobbling up shares of Verizon (VZ) over the past year. The biggest draw is the telecom giant’s monster 7.5%-yielding dividend. While there have been some questions about that payout’s sustainability — which have weighed on its share price and pushed up its dividend yield — the company’s improving cash flow and balance sheet suggest the dividend should keep rising.

I recently bought a few more shares of Verizon, my sixth purchase in the past year. Here’s why I can’t seem to get enough of the company’s big-time payout.

Already on a sustainable foundation
Verizon produces a prodigious amount of cash. In 2022, the telecom giant generated $37.1 billion in cash flow from operations. While that was down from $39.5 billion in 2021, it covered its capital expenses ($23.1 billion) with ample room to spare ($14.1 billion in free cash flow).

This allowed the company to easily fund its dividend ($10.8 billion). That left it with $3.3 billion in excess free cash last year.

That excess free cash helped strengthen the company’s already solid balance sheet. Its leverage ratio fell from 2.8x at the beginning of the year to 2.7x by year-end. That supported its strong investment-grade bond ratings of A-/BBB+/Baa1.

These metrics suggest Verizon’s dividend is on a firm financial foundation.

Reaching an inflection point
While Verizon’s dividend is already on solid ground, its financial foundation is about to get even stronger. The company’s heavy investments in 5G are starting to pay off.

Its total revenue increased by 3% during the quarter, driven partly by a 5.3% increase in total wireless postpaid gross phone additions. That helped increase its cash flow from operations by $1.5 billion, while free cash flow improved by $1.3 billion.

Even without that revenue growth, free cash flow was on track to see a meaningful improvement in the coming quarters. The company recently finished funding its C-Band-related spending program to improve its 5G capabilities. It funded most of the remaining $1.8 billion of that three-year, $10 billion investment during the first quarter.

As a result, capital spending will decline meaningfully in the coming quarters. The company expects 2023 capital spending to be $18.3 billion-$19.3 billion this year while falling to around $17 billion next year (more than $5 billion below 2022’s total).

To top it all off, the company launched a new cost-cutting plan last fall to shave another $2 billion to $3 billion from its operating costs by 2025. With revenue growing and costs falling, operating cash flow should improve. Add in lower capital spending, and Verizon’s free cash flow should meaningfully increase in the coming years.

Growing stronger
Verizon plans to continue using its excess free cash flow to strengthen its balance sheet. The company’s long-term target is to get leverage down to a range of 1.75x to 2x, putting it in an even stronger financial position. However, it plans to allocate free cash to start repurchasing some of its attractively priced shares once leverage falls below 2.25x.

The company’s long-term deleveraging plan won’t impact its dividend. Verizon intends to continue steadily growing the payout. It increased its dividend by 2% late last year. That marked the 16th straight year of dividend growth, the longest current streak in the U.S. telecom sector.

Attractive income with upside potential
Verizon’s heavy investments in 5G are starting to pay off. Along with cost cuts and reduced capital spending, this should enable it to produce even more free cash. That will allow it to strengthen its already rock-solid balance sheet and continue increasing the dividend.

These catalysts should eventually boost Verizon’s valuation. In the meantime, I’m content to collect its massive dividend. I plan to keep buying shares hand over fist as long its yield remains attractive.

— Matthew DiLallo

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Source: The Motley Fool