Dancing With Dividends

12:25 PM -- Telecom stocks have found themselves riding higher based on the attraction of their dividends. At a time when interest rates on other investments are pitifully low, those dividends are attractive.

Verizon Communications Inc. (NYSE: VZ) shares were up 21 percent Monday from their low in July. But in lowering his rating on Verizon from "market perform" to "market underperform," Craig Moffett of Sanford C. Bernstein & Co. Inc. is calling the market's bluff on dividends.

The problem, Moffett explained in an interview this morning, is that wireline companies such as Verizon, CenturyLink Inc. (NYSE: CTL), Qwest Communications International Inc. (NYSE: Q), and others, are seeing their core businesses shrink, and that calls into question whether they can sustain their dividend payouts, much less grow them.

"If you can get a 4 percent bond yield and a 6 percent dividend on the equity -- you are getting the equity upside for free, but you are also getting the downside," Moffett says. "The market is arguing that they expect equity to shrink 2 percent a year in order to fund the dividend. I would argue that is a bit optimistic. You have to think long and hard about the sustainability of the dividend and the risk inherent in a payout ratio that is this high. "

Verizon doesn't generate enough cash flow and its wireline debt makes that part of the company a net drag on business, not the core cash-generating machine it was in the past, Moffett says. The same holds true for other wireline operators.

Verizon Wireless has tremendous upside, but Verizon only owns 55 percent of that upside. "It is still 55 percent a wireline business and only 45 percent wireless," he says.

AT&T Inc. (NYSE: T) has a much more comfortable dividend payout ratio, relative to other telecom service providers, but not relative to other S&P 500 companies that are paying dividends, Moffett says.

— Carol Wilson, Chief Editor, Events, Light Reading

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