It’s unbelievable that BCE (TSX:BCE) stock now offers a dividend yield of 8.5%! Not too, too long ago, the big Canadian telecom stock peaked at approximately $73 per share in April 2022. At that time, the stock yielded 5%.
Big dividend yields are warning signs that are flashing for a potential dividend cut. Is a dividend cut coming for BCE stock? It’s certainly hard to swallow the possible idea of a dividend cut for a perceived blue-chip stock like BCE.
The large-cap stock has increased its dividend every year since 2009. Its 10-year dividend-growth rate is around 5%, while its latest dividend increase was about 3% in February. Investors like dividend hikes because they get a growing passive income. However, slowing dividend growth could be another warning sign.
The big telecom is a capital-intensive business. It borrows to make long-term investments for the business. So, it has a big portion of debt on its balance sheet. In the last reported quarter, it had $52.2 billion of debt on its balance sheet, including $32.2 billion of long-term debt. Its debt-to-equity and debt-to-asset ratios were 2.6 times and 72%, respectively. Interest expense in the trailing 12 months (TTM) was $1.6 billion.
Compare that to back in 2021 when BCE had $43.8 billion of debt on its balance sheet, including $27 billion of long-term debt. Back then, its debt-to-equity and debt-to-asset ratios were 1.9 times and 66%, respectively. And its interest expense was $1.1 billion for that year.
The higher interest expense can be explained by higher debt levels and higher interest rates. Since interest rates began rising in 2022, stocks with underlying businesses that have large debt levels have fallen because new debt or refinanced debt will result in higher interest costs and, therefore, growth will slow. It was a rapid increase with the Bank of Canada raising the policy interest rate from 0.25% to 5%. That said, the policy interest rate seems to have stabilized at 5% for now.
Will BCE cut its dividend?
Investors are likely most concerned about the sustainability of BCE’s dividend, as many investors buy and hold BCE for dividend income. First, BCE is a slow-growth business. From 2011 to 2021, it increased its diluted earnings per share by only 3.8%, which is a compound annual growth rate (CAGR) of 0.38%. Its adjusted earnings per share increased by 1.9%, or a CAGR of 0.19%. Even in this period of low interest rates, the telecom experienced low growth.
Second, BCE has been raising its dividend at a faster pace than earnings. In the period, it increased its dividend by almost 72%, or at a CAGR of nearly 5.6%. So, based on earnings, its payout ratio has been overextended since 2020. Its 2023 payout ratio was about 121% based on adjusted earnings.
Its dividend has better coverage from cash flow. From one perspective, last year, 60% of BCE’s operating cash flow went into capital spending, which is a long-term investment needed for the business. This percentage aligned with the 63% of operating cash flow used for capital spending from 2019 to 2022. From another perspective, one could also say that BCE borrowed to make those long-term investments. In this case, 46% of its operating cash flow went into paying out dividends last year.
Some investors use the stricter free cash flow metric to determine dividend safety. Free cash flow is operating cash flow minus capital spending. In this case, the payout ratio was 121% in the TTM.
At the end of the day, it’s anyone’s guess if BCE will cut its dividend. Based on its track record of dividend payments, management seems keen on keeping the dividend. However, given the slow-growth business, higher interest expense, and high payout ratios, it may be in the company’s best interest to reduce the dividend to more sustainable levels.
