AT&T’s Dividend: The Impact Of Eliminating It Altogether
Contributor since 2012 / 37532 Followers
Summary:
- AT&T Inc. has over $130 billion in debt.
- Higher for longer interest rates are going to wreak havoc in interest expense.
- When considering the dividend, management forecasted $16 billion in free cash flow, but half of this goes to the dividend.
- AT&T could actually increase the dividend, but it could fast-track itself to being debt free by eliminating it altogether.
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After a bombshell dividend cut from one of our core long-term holdings in Intel Corporation (INTC), we have started to take a look at our long-term holdings where dividends have been rumored to be at risk. This is separate from our more short and medium-term trading guidance. Remember, your trading goals should be to generate extra cash flow to feed a longer-term core portfolio that has dividend growth. That is something that we guide on for our membership.
While we teach trading, we preach investing. With that said, we today turn our attention to a name that we have long been exposed to over the years in some capacity. Only for a brief period was AT&T Inc. (NYSE:T) swapped out of our core holdings when it proceeded to fall 30% during the debacle of the DIRECTV offloading and the spinoff of Warner assets. The current “legacy” type AT&T inc. continues to be a name we own, one that is leaner, and seemingly has a management team that is finally cognizant of the fact that it has destroyed shareholder wealth over the years. We have liked buying the new AT&T in the $16-$18 range, generally speaking, but this is entirely reliant on the fact that a bountiful 6% plus dividend yield is being offered at those levels.
Take a look at the analysis section of AT&T on Seeking Alpha. There are tons of great opinion and analysis pieces both bullish and bearish. Some of them talk about the dividend. It has long been our opinion that the dividend is the sole reason to own this stock. Collect it for income, or reinvest the dividends for long-term compound gains to build a position and then live off of the dividends in retirement. Only recently, when the stock hit the mid-teens did some capital growth seem possible. But if the dividend were to be cut hard, and there are legitimate arguments to be made for why that may be a positive, we think shareholders would flee and the stock could fall as far as the single-digits. This is because it is owned in large part by income investors.
The number one risk to the dividend? It is the debt. Simple as that. Overall, the dividend, as it currently is paid out of cash flow, is safe. This is a far cry from Intel, whose cash flows were turning negative and the company was losing money. While AT&T may be a dinosaur that grows at a snail’s pace, it is not losing money. And we will add, that wireless connectivity is rather recession-resilient in our opinion, because people do not want to lose their connectivity.
So we have opined that the debt is the number one risk to the dividend. An argument can be made that cutting the dividend can save billions of dollars that would go to shareholders, and could be applied to the massive principal balances of debt. Make no mistake, this high debt burden in a time of rising interest rates, and interest rates that will be “higher for longer,” means the company’s refinancing efforts or new debt taken on will come at higher interest expense, hurting the bottom line.
Members, this is a real problem. This debt burden is one of the biggest risks not just to the dividend, but to AT&T stock in general. To management’s credit, it has been improving the balance sheet. Management has been selling off assets and paying down its debt. Just this week we learned that the company is exploring yet another sale, this time of its cybersecurity business, an area that is red hot right now. When the company reported earnings a few weeks ago we saw that at quarter end the net debt was $132.2 billion. That is still a pretty high leverage base, as net debt-to-adjusted EBITDA was just under 3.2X. That said, AT&T cut its net debt by $24 billion in 2022 through all of the divestitures and asset sales, and it’s looking to trim another $30 plus billion by 2025, targeting about $100 billion in net debt, taking leverage under 3X.
If the dividend were eliminated, in theory, AT&T could eliminate its debt in less than a decade. Why do we say this? Well, in Q4 dividends paid were $2.01 billion. So that means on an annual basis the company is paying out $8 billion. So over ten years that is $80 billion, roughly. Plus the company is already making principal and interest payments, and is still selling off assets. Based on the most recent debt balance, AT&T could pay off all debt in less than a decade if it did this. While an argument can be made for a cut, it is our hypothesis that the dividend will be held firm, even though there is actually room for a dividend increase. Yes, a dividend increase. We are not saying an increase is in the cards, and we actually do prefer debt to be addressed while keeping the dividend firm.
Why do we say there is room for an increase? Well, historically the company aimed for a 70% payout ratio, that is, the ratio of dividend paid from free cash flow. We saw a free cash flow dip in 2022, but the ship is being righted. In Q4, there were $31.3 billion in revenues. Operating expenses were $25.6 billion. Operating income grew $700 million to $5.7 billion compared to last year. But it comes down to free cash flow. Free cash flow has been more than sufficient to cover the dividend, although the payout ratio for the year 2022 was a concern. But in Q4, it was well covered.
Cash from operating activities was $10.3 billion, and capex spending from the company was a little over $4.1 billion. Q4 free cash flow was $6.1 billion. As we mentioned above dividends paid were $2.01 billion. That left around $4.1 billion in free cash flow after the dividend was paid. Doing the math the Q4 dividend payout ratio from free cash flow. was a very safe 33.0%. Despite some rough quarters in early 2022, the payout ratio for the year was around that 70% mark.
As we look to 2023, and beyond, we all know that debt needs to be paid down. A dividend elimination in theory, in conjunction with ongoing debt servicing and more asset sales, could lead to a debt-free AT&T in decade. A dividend cut could extend this time line but could allow excess free cash flow to be used for debt. How much free cash flow are we talking? Well, we see free cash flow of $14.5-$16.75 billion. The lower end assumes a moderate recession in 2023 and the higher end prices in a soft landing. We see revenue growing 3%-6% with more customer adds a pricing power.
A bearish argument could be made that there is stiff competition and promotions will erode margins, but recent data disagrees. We see earnings coming in around $2.30-$2.55 for the year, depending on the extent of economic damage from the rate hikes. When considering the dividend, management forecasted $16 billion in free cash flow, which means the dividend payout ratio would be around 50% for the year. That leaves room for a dividend hike if management wants to target a 70% payout ratio. But we believe the dividend will be held firm, while paying down debt over the next 20 years.
What to do?
Arguments can be made for and against raising, cutting, or even eliminating the dividend. For us, this is an income name. At about $20, a share we think this is a hold, and stand by a buy zone the centers around $17. The dividend appears safe as far as the payout ratio is concerned, and it is such a nice cushion that free cash flow supports a possible hike depending on the target payout ratio management sees in the future.
We see the AT&T Inc. dividend being held firm, which means you will collect a 6%-plus dividend yield while debt continues to be addressed. In our opinion, every $10 billion decline in debt makes AT&T stock more and more attractive as the balance sheet becomes less leveraged. We do not see the dividend at risk, but do recognize that if it were cut it would fast-track the company to paying off debt. While it would cause a massive rotation out of the stock, if it were to happen, it could result in a much stronger company long-term. However, we believe it will be held firm.
Speak up
After reading this and other opinions, do you think AT&T Inc. should prioritize debt by cutting or eliminating the dividend? Should AT&T Inc. raise the dividend? Is it even worth buying here when you can get over a 5% return on a 6-month treasury? Let the community know below.
Disclosure: I/we have a beneficial long position in the shares of T either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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