The telecom sector is full of great dividend payers who consistently increase their payouts year after year. But one of the industry's newest dividend payers claims it may be the best choice for long-term dividend investors.
T-Mobile (NASDAQ:TMUS) declared a dividend last September. A year later, it announced its first-ever dividend increase – and it was a big one. Shareholders will receive $0.88 per share each quarter starting in December, a 35% increase over T-Mobile's original dividend. Moreover, management promises double-digit dividend growth in the coming years.
This is why T-Mobile is perhaps the best dividend stock among the telecom giants.
Everything about cash flow
Since completing its merger with Sprint in 2020, T-Mobile has delivered tremendous free cash flow growth to shareholders. Free cash flow grew from $3.2 billion that year to $13.6 billion last year. Management expects free cash flow to increase to between $18 billion and $19 billion over the next three years.
For reference: T-Mobile's biggest competitors, AT&T And Verizongenerated free cash flow last year of $16.8 billion and $18.7 billion, respectively. The two expect to maintain similar levels of free cash flow this year.
T-Mobile has been able to grow its free cash flow to levels close to those of more established competitors, with consistent execution that exceeds initial expectations. For example, since integrating Sprint, management has realized more than $8 billion in merger synergies, exceeding the target of $7.5 billion in 2021. It also completed network integration a year ahead of schedule.
T-Mobile's spectrum portfolio allowed it to bid more strategically at FCC auctions for additional bands, meaning it didn't have to pay exorbitant prices for new airwaves. As such, it could focus its capital investments on building out its 5G network, which is well 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 is fixed assets. It has expressed interest in the area and has partnered with Metronet and Lumos to take advantage of their fiber assets. T-Mobile's model for leasing most fixed assets keeps capital expenditures low, but does incur ongoing costs.
That said, T-Mobile has shown that the strategy works well. Its wireless customer base has grown faster than its competitors, and its home Internet subscriber base is growing faster than its competitors combined. It is now targeting 12 million home internet subscribers by 2027, mainly making use of the extra capacity of its 5G network. The result is a strong conversion of service revenue to free cash flow.
T-Mobile plans to return most of that free cash flow to shareholders.
How much could the dividend continue to grow?
At the investor day, management said it expects to generate $80 billion in “cumulative cash flexibility” between now and 2027. 50 billion of this is intended for T-Mobile's capital return program, which mainly consists of share buybacks.
T-Mobile's dividend remains a small part of the capital return. During the first year of the dividend, T-Mobile returned a total of approximately $3 billion in cash to shareholders. Even with the big 35% increase, T-Mobile will only pay out about $4 billion over the next year.
Because T-Mobile uses much of its extra capacity to buy back shares, it increases its ability to increase its dividend in the future. Since there are fewer shares to pay a dividend on, it has more money per share to pay out.
Management said it is targeting a mid-20% share of free cash flow for its dividend. So if free cash flow is about $18.5 billion in 2027, that equates to a total dividend payout of about $4.6 billion. That would translate to about 10% dividend increases in each of the next two years as management aggressively reduces its share count.
Management also noted that there is an additional $20 billion in the budget, which could be used for strategic investments or acquisitions. But if there is any extra money left, the shareholder return program will likely be the beneficiary.
Importantly, there is a lot of room for T-Mobile to increase its dividend as a percentage of free cash flow over time, as cash flow in the sector is very predictable. AT&T and Verizon paid out 48% and 59% of free cash flow in dividends last year, respectively.
T-Mobile's shares are priced higher than AT&T and Verizon. Its enterprise value (EV)/EBITDA ratio of 12 is higher than both AT&T (6.8) and Verizon (8.8). But with strong EBITDA and free cash flow growth on the horizon, T-Mobile is worth the premium price. At its current share price, T-Mobile's 1.7% yield may not look all that attractive compared to the older telecom giants, but the potential for total returns from share buybacks and dividend growth over time is extremely attractive 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 increased its dividend by 35% and promises many more double-digit increases. Originally published by The Motley Fool
