This telecom giant just raised its dividend by 35% and promises many more double-digit increases to come

The telecommunications industry is full of high dividend payers that consistently increase their payouts year after year. But one of the industry’s newest dividend payers says it could be the best bet for long-term dividend investors.

T-Mobile (NASDAQ: TMUS ) instituted a dividend last September. A year later, it announced its first 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 initial dividend. In addition, management is promising double-digit dividend growth for years to come.

Here’s why T-Mobile might be the best dividend stock of the bunch among the telecom giants.

All about cash flow

Since completing its merger with Sprint in 2020, T-Mobile has produced massive growth in 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 grow between $18 billion and $19 billion.

For reference, T-Mobile’s biggest competitors, AT&T and Verizonproduced free cash flow of $16.8 billion and $18.7 billion, respectively, last year. The two expect to maintain similar levels of free cash flow this year.

T-Mobile was able to grow its free cash flow to levels close to its more established competitors, with consistent execution beating initial guidance. For example, management delivered more than $8 billion in merger synergies from the Sprint integration, above the target of $7.5 billion in 2021. It also completed the network integration a year earlier than planned.

T-Mobile’s spectrum portfolio ensured it could bid more strategically in FCC auctions for additional bands, which meant 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 remains 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 landline assets. It expressed 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 expenditures low, but comes with ongoing costs.

That said, T-Mobile has shown that the strategy is working well. Its wireless customer base has grown faster than its competition, and its home Internet subscriber base is growing faster than its competitors combined. It is now targeting 12 million home internet subscribers by 2027, primarily leveraging the added capacity of its 5G network. The result is a strong conversion of service revenue into free cash flow.

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T-Mobile plans to return most of this free cash flow to shareholders.

How much could the dividend continue to grow?

On investor day, management said it expects to generate $80 billion in “cumulative cash flexibility” through 2027. Of that, $50 billion is allocated to T-Mobile’s capital return program, which consists of principally in share buybacks.

T-Mobile’s dividend remains a small fraction of its return on capital. During the first year of the dividend, T-Mobile paid a total of about $3 billion to shareholders in cash. Even with the hefty 35% increase, T-Mobile will only pay out about $4 billion over the next year.

As T-Mobile uses much of its additional capacity to repurchase shares, it increases its ability to raise its dividend in the future. With fewer shares on which to pay a dividend, it has more money per share to pay out.

Management said it is targeting a 20% share of free cash flow for its dividends. So if free cash flow comes to about $18.5 billion in 2027, that’s a total dividend payout of about $4.6 billion. That would translate into dividend increases of around 10% in each of the next two years as management aggressively reduces its share count.

Management also noted that there is another $20 billion in the budget that could be used for strategic investments or acquisitions. But if there are additional funds, the shareholder return program is the likely beneficiary.

Importantly, T-Mobile has plenty of room to grow its dividend as a percentage of free cash flow over time, as cash flow is highly predictable in the industry. AT&T and Verizon paid out 48% and 59% of free cash flow in dividends last year, respectively.

T-Mobile’s stock is priced higher than AT&T and Verizon. The enterprise value (EV) to 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 the current share price, T-Mobile’s 1.7% yield might not look that appealing compared to older telecom giants, but the potential for total return 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 listed stocks. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.

This telecom giant just raised its dividend by 35% and promises many more double-digit increases to come was originally published by The Motley Fool