ASX dividend stocks: Unpacking one of the market's biggest yield traps

I'm on a mission to uncover some of the market's most compelling dividend-paying stocks. The aim is to provide readers with the key data and forecasts to make more informed decisions. Today, we're reviewing Spark New Zealand.

Spark New Zealand (ASX: SPK), New Zealand's largest internet service provider, delivers a broad suite of telecommunications services including fixed-line telephone services, mobile networks, internet connectivity, and digital technology solutions. While the company has maintained a consistently yield of approximately 6% between 2021-2023, which also soared to 11.6% in 2024, this payout masks some troubling fundamentals.

Behind these dividends lies a share price that has steadily eroded over three consecutive years, notable a 44% decline in 2024 and a further 30% decline year-to-date. The downward spiral flags a classic situation where the yield has been propped up by a rapidly diminishing share price, rather than genuine financial strength.

Key stats

• Market cap: $3.6 billion

• PE ratio: 20.1

• 12-month performance: -30%

• 12-month price range: $1.875 - $4.64

• Trailing 12-month dividend yield: 12.2%

The downward spiral

Despite operating in the relatively defensive telecommunications sector, Spark's underperformance stems largely from New Zealand's challenging economic landscape. The country has slipped into two technical recessions (defined as two consecutive quarters of negative GDP growth) in the first quarter of 2023 and again in the third quarter of 2024.

The latest September quarter data revealed a concerning 1% contraction in GDP and a 1.2% decline in per capita GDP. Macroeconomic headwinds – including a cost-of-living crisis and supply chain disruptions – have significantly reduced consumer spending and business investment, directly impacting demand for telecommunications services.

These challenges have triggered a cascade of earnings downgrades and disappointing results:

• May 15, 2024: Spark downgraded its FY24 EBITDA guidance by 3.8% (at the midpoint) from $1.21-1.26 billion to $1.17-1.21 billion, citing deepening public and private sector spending cuts resulting in lower IT service revenue and reduced mobile handset and enterprise sales. Despite weaker earnings, the company maintained its dividend per share guidance of 27.5 cents.

• August 22, 2024: Spark shares plunged 7.5% after FY24 EBITDA missed even its downgraded guidance, coming in at $1.16 billion. The company projected EBITDA of $1.16-1.2 billion for FY25.

• October 30, 2024: Spark further downgraded its FY25 EBITDA guidance by 3.5% (at the midpoint) to $1.12-1.18 billion and reduced its dividend guidance by 2.5 cents to 25 cents per share. The company attributed this to "a combination of cyclical and structural headwinds," with mobile revenue and IT margins most severely impacted.

• February 21, 2025: In its most alarming report yet, Spark announced 1H25 EBITDA of $419 million – down 21% year-on-year and missing market expectations by 22% ($535m). Consequently, the company slashed its FY25 EBITDA guidance by 7% to $1.04-1.1 billion.

For two straight years, positive news from Spark has been nonexistent. Yet, the company continues to promise a substantial dividend, even as market analysts express serious concerns that free cash flows may be insufficient to cover the promised 25 cents per share. Macquarie's analysis suggests Spark's earnings can sustainably support only an 18 cents per share dividend.

In its latest financial report, the company announced plans to review its capital management strategy, including its dividend policy, later in calendar year 2025.

The bottom line

Despite operating in what should be a defensive telecommunications sector, Spark continues to demonstrate vulnerability to reduced (and still downgrading) consumer spending in mobile and broadband segments, compounded by significantly lower government and enterprise spending.

The share price freefall shows no signs of abating, with the stock plummeting a further 12% since its half-year result announcement in February. At just $1.87 per share and a dividend guidance of 25 cents per share, Spark now presents an attractive dividend yield of 13.3%.

However, for a company that has already downgraded its FY25 guidance on three occasions times, what is the likelihood that investors will actually receive the full dividend by year end? And how much further will the stock fall to reflect ongoing headwinds?

Spark's downward spiral should serve as a powerful lesson to investors that:

• Earnings downgrades typically come in clusters

• Recessions seriously undermine the earnings capability of most companies, even those in supposedly defensive sectors

• If a dividend yield sounds too good to be true, it probably is