Telstra Corporation Ltd (ASX: TLS) is one of the most popular dividend stocks on the ASX.
However, while the per share dividend payout hasn't grown substantially in recent years, Telstra's ability to pay its dividend in the good times and the bad is what makes it so good.
For example, since 2003, Telstra has not once cut its dividend.
And along with the divestment of some of its underperforming businesses, its dividend payout has actually started increasing in recent years.
But with roughly $15.6 billion in debt, is Telstra's ability to continue paying its dividend in doubt?
I don't think so.
One way investors can gauge whether a business is healthy, is to determine its free cash flow to firm (FCFF), or just free cash flow.
Free cash flow takes into consideration usual operating expenses, tax, working capital and capital expenditures to arrive at a figure which is essentially what the CEO has in his or her pocket at the end of a year. This figure will vary significantly from profit.
In its 2015 financial year, I estimate Telstra generated free cash flow of around $5.6 billion – which is excellent.
Meanwhile, it paid just $3.7 billion in dividends, meaning there's plenty of cash leftover to service debt or other capital management initiatives.
A simple way to gauge a company's debt servicing ability is to compare EBITDA (earnings/profits before interest, tax, depreciation and amortisation) to interest payments on its debt. Telstra's interest cover was a hefty 12.7x.
Generally, a ratio greater than 1x indicates a company has enough earnings coverage to pay its interest expenses.
Telstra's impressive result is partly attributable to the drop in interest expenses (as a percentage of total debt), as well as a slight reduction in total debt.
Is it safe or not?
With underperforming businesses being sold down and cash payments from the NBN Co set to start rolling in, Telstra's dividend appears quite reliable in my opinion.
Although its payout ratio (as a percentage of profits) is already very high, its debt repayments appear well managed and well funded. However, it is important to remember Telstra may cut its dividends in the future, however unlikely that may appear now.
Moreover, I'd much rather Telstra lower the dividend in any given year than pay dividends from debt.
