Justin Sullivan
Let’s be honest. T-Mobile US, Inc. (NASDAQ:TMUS) has made a living by first imitating and then doing at least some things better than AT&T (T) and Verizon Communications Inc. (VZ). So much so that T-Mobile is now a larger company than the two giants in terms of market cap, although the Sprint merger played a big part in that.
My very first individual cellular plan was with T-Mobile in 2007 and back then, T-Mobile was still in its early years (only renamed T-Mobile in 2002) and was a value player in the market, offering cheaper plans compared to the big boys. The company’s image, as well as the lives of its competitors, took an interesting turn in 2012 with the appointment of dynamic John Legere as CEO. Mr. Legere is often credited as the one who introduced the contract-free plans, which consumers were able to enjoy, at least in some cases. Let’s just say he knew how to get under his rivals’ skin. But he also knew how to run this business and take it to the next level. During his 8-year tenure, T-Mobile’s revenue more than tripled from $20 billion in 2012 to $68 billion in 2020 when he departed.
TMUS earnings (statista.com)
I moved away from T-Mobile for a few years and returned to T-Mobile last week, this time for a family plan. It’s still early days, but so far so good as a T-Mobile customer. The coverage and speed have been fantastic and the pricing is still competitive along with enticing upgrade/trade-in options. As a (for now) satisfied customer, my thoughts immediately turned to the world of investing. Can T-Mobile emulate and outperform AT&T and Verizon in the key area most investors think the latter two stocks represent? dividends. let’s find out
As before, T-Mobile will not pay any dividends. So this exercise involves some assumptions. AT&T’s current yield is about 6%, while Verizon is yielding about 7%. Let’s say T-Mobile starts with half AT&T’s yield, say 3%. A yield of 3% based on the current share price of $142.50 means an annual dividend of $4.28. (Or a quarterly dividend of $1.07/share). T-Mobile’s expected EPS is estimated at $7.30. Therefore, an annual dividend of $4.28 translates into a payout ratio of about 60%. That’s a pretty reasonable number. Readers may recall that I prefer Free Cash Flow (“FCF”) to EPS. This becomes particularly critical for capital-intensive businesses such as communications services. So let’s check the (imaginary) split coverage with FCF. T-Mobile has an outstanding share count of 1.219 billion. That means to meet my dividend assumption above, T-Mobile should generate average FCF of $1.30 billion each quarter. That is, 1.219 billion times $1.07. On an annual basis, that’s $5.21 billion needed to cover the assumed dividend. T-Mobile’s highest quarterly FCF over the last 5 years was $941 million, with an average of -$700 million. I found it hard to believe that the company actually ran out of cash after covering operating and capital costs. I generally trust YCharts numbers, but that seemed a bit unbelievable considering the growth T-Mobile has seen since I last followed them as a consumer. So I took the Financials on Seeking Alpha and the negative FCF numbers as actually true. As shown below, T-Mobile has not had a positive FCF per share since 2013, with 2022 being the closest at minus 42 cents. For comparison, in 2022 AT&T earned 1.73 FCF per share and paid $1.11 in dividends. Verizon earned 2.48 FCF per share and paid $2.61 in dividends.
FCF Seeks Alpha (Seekingalpha.com)
FCF Seeks Alpha (Seekingalpha.com)
Does that mean T-Mobile can’t afford to pay dividends at all? Don’t give up so easily. T-Mobile’s merger with Sprint was huge, to say the least. Any integration of this magnitude will take time to produce the synergies predicted/promised at the time of the merger. Additionally, T-Mobile has spared no expense in becoming the 5G leader (and the results show, as a returning customer I can attest). However, the company is now significantly reducing its investments and has forecast an FCF of $13 billion for 2023 with the expectation that it will reach $18 billion in 2026. Now go back and review the FCF-based dividend coverage above. An annual dividend obligation of $5.21 billion means a payout ratio of 40% if the company follows through on its 2023 FCF guidance. The payout ratio drops to 29% using the projected $18 billion in 2026.
Diploma
I’d wager that T-Mobile will most likely be a dividend stock within the next three years. If the FCF figures meet or exceed these expectations, a buyback cannot be ruled out. The stock currently appears fairly valued on the surface at a forward multiple of 20. But again, the surface can be misleading as TMUS stock could soar massively over the next five years based on its expected earnings growth rate of 64% per year, here with a price-to-earnings-growth (“PEG”) of 0.30 undervalued.
That said, while investing is all about the future, it’s also important not to count your chickens before they hatch. I’m excited to review T-Mobile’s free cash flow this year, but for now I rate the stock as a hold but a must-have for income investors.
