Telefónica (TEF): Is the High Dividend Yield a Trap?

Investors seeking income often chase high yields, but Telefónica (TEF), the Spanish telecommunications giant, offers a cautionary tale. With a dividend yield of 6.51%, its shares might look like a bargain. However, beneath the surface lies a dividend sustainability crisis that could turn this yield into a trap. Let's dissect the risks.

The Declining Dividend: A Long-Term Trend

Telefónica's dividend has been shrinking at an annual rate of 8.8% since 2015, when shareholders received €0.75 per share annually. By 2025, the payout has been slashed to €0.30 per share annually—a 58% reduction over a decade. .

The erosion is not accidental. The company has relied on unrestricted reserves to fund dividends since 2022, as its core earnings have cratered. In 2024, Telefónica reported a net loss of €49 million, yet maintained dividends through non-cash adjustments. This has pushed its payout ratio to a staggering -532%, meaning dividends far exceed earnings. While free cash flow (FCF) of €2.63 billion in 2024 temporarily shields the dividend, this metric ignores the fact that FCF is being siphoned to prop up payouts rather than invest in growth.

The EPS Deterioration: A Weaker Foundation

Dividends are only sustainable if earnings grow or stabilize. Here, Telefónica fails miserably. Earnings per share (EPS) have declined at a 29% annual rate over the past five years, a collapse driven by asset impairments, declining revenue in key markets, and costly investments in fiber-optic networks. Even the modest EPS rebound in 2024 (+13%) is fragile, relying on one-time gains and cost cuts.

Near-Term Comfort vs. Long-Term Risk

Short-term positives include:
- A cash flow coverage ratio of 35% (dividends funded by FCF), which keeps payouts afloat for now.
- A 7.6% yield (as of May 2025) that attracts yield-starved investors.

But long-term risks loom large:
1. Balance Sheet Strain: Telefónica's net debt-to-EBITDA ratio remains elevated at 2.7x, limiting its ability to absorb shocks.
2. Earnings Volatility: Without sustained EPS growth, the dividend will remain a “paper dividend” reliant on reserves, not profits.
3. Competitive Pressures: In markets like Brazil, where its subsidiary Claro faces aggressive pricing from rivals, margins are under threat.

Why This is a High-Yield Trap

The dividend's 6.51% yield is a siren song, but it's built on shaky ground. If Telefónica's earnings fail to stabilize, the dividend could face another cut, triggering a stock price collapse as income investors flee. This is not a risk to dismiss: in 2022, the company already halved its payout to €0.15 per share.

The Bottom Line: Proceed with Extreme Caution

Telefónica's dividend is a mirage for income investors. While the €0.15-per-share quarterly payout feels reliable today, its -532% payout ratio and -29% EPS decline scream of unsustainability.

For income seekers, better options exist: telecom peers like AT&T or Verizon offer lower yields (4-5%) but with positive payout ratios and stable earnings. Telefónica's high yield is a warning sign, not a buy signal.

Recommendation: Avoid Telefónica for income portfolios. Prioritize companies with rising EPS, positive payout ratios, and sustainable cash flows. The dividend may hold for now, but the risks of a cut—and the resulting sell-off—are too great to ignore.

Invest wisely, not recklessly.