New York, December 11, 2012 -- Yield-hungry investors have driven US telecom stocks to large valuation premiums, but these are unlikely to be sustainable, Moody's Investors Service says in a new report, "Dividend Dilemma for Telecoms: How to Support Stock Prices When Interest Rates Rise."
"Low rates have drawn income-seeking investors to the telecommunications sector, but given the sector's slow growth, current equity premiums are likely to come under pressure from higher dividend tax rates following the 'fiscal cliff' talks in the short term, and from rising interest rates in the longer term," says analyst and author of the report Mark Stodden.
This could set the stage for credit negative actions as companies seek to support their stock prices, Stodden says. They could increase dividends in line with interest rates, seek growth through debt-financed capital investments or M&A, or borrow to buy back shares. All these actions could lead to higher leverage, and ultimately pressure companies' ratings.
If fiscal cliff negotiators allow the current 15% dividend tax rate to expire at the end of this year, a 35% dividend tax rate would reduce the weighted average after-tax telecom dividend yield to 3.4% from 4.5%, narrowing its risk premium to the 10-year Treasury yield by 105 basis points.
And the 10-year US Treasury yield is projected rise to 4.1% in late 2015 from about 1.6%, also making telecom stocks less attractive. "Combined with a 35% dividend tax rate, we estimate that the premium of the after-tax telecom dividend yield to the 10-year Treasury could decline to 80 basis points from 345 currently," Stodden says.
Among the large telecoms, AT&T has announced plans to increase leverage to fund additional capital investment and continue share repurchases, while Verizon has less flexibility to act due to its lower rating and limited free cash, but the most incentive to do so. The smaller, lower-rated companies have still less flexibility, and are currently trying to reduce their debt while at the same time maintaining their credit profiles and sustaining high dividend payouts.
Moody's research subscribers can access this report at http://www.moodys.com/research/US-Telecommunications-Dividend-Dilemma-for-Telecoms-How-to-Support-Stock--PBC_147762.
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Mark StoddenAsst Vice President - Analyst Corporate Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653John Diaz MD - Corporate Finance Corporate Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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