In April of last year, a month before announcing the split of its media division to shareholders in the form of shares of a 71% stake in the new Warner Bros. Discovery,
Chief Executive John Stankey assured investors that “our deliberate capital allocation plan has allowed us to invest and maintain our dividend at current levels, which we believe to be attractive.” He did not mention any increase. AT&T’s eventual failure to raise the dividend in 2021 broke a 34-year streak and saw it kicked out of the vaunted S&P 500 Dividend Aristocrats Index.
Conservative retail investors hold a disproportionate stake in AT&T due to its bond nature. Many were even more upset when he announced a 47% reduction in his payment this year as part of the spin-off, which was completed in May. Their stake in the combined media company was a mediocre consolation prize, with a current market value equal to just three years of the 97 cents per share dividend cut. Investors have sent shares of AT&T down 17% since it first reported quarterly results as a standalone telecommunications company in July, with doubts even hovering over the drop in payouts.
“There is no problem with the security of the dividend, period,” CFO Pascal Desroches insisted in an interview on Wednesday. “As a management team, you cannot cut the dividend twice.”
That’s right – another cut would be career-shattering. Still, the company lowered its 2022 free cash flow forecast, which funds its $8 billion dividend, for the second time this year in July. It has gone from $20 billion to $16 billion and more recently to just $14 billion.
It sounds bad, but Mr. Desroches deserves the benefit of the doubt. Part of this projected reduction stems from the removal of the media industry contribution for part of the year, and part is due to surprisingly strong subscriber growth: AT&T pays up-front subsidies for smartphones when customers sign on the dotted line. The actual forecast cut was more like $2 billion. Meanwhile, following the stock price decline, AT&T’s dividend yield is now 6.6%, the fifth highest in the S&P 500 index.
It’s a small consolation for shareholders who receive smaller coupons, but the previous payment seemed unsustainable. By unloading about $43 billion in debt with the fallout and billions more with the partial DirecTV fallout, AT&T not only ended its disastrous media banter, but also gained more breathing room.
Numbers alone do not tell this story. AT&T remains the most indebted non-financial company in the United States in absolute terms and has an unhealthy ratio of 3.2 times net debt to expected earnings before interest, taxes, depreciation and amortization, which is not too different from last year, before the spin-off. It’s more like 3.7 times, including preferred stock, leases and retiree benefits. Either multiple could justify putting a telecommunications company’s debt in junk territory, but the rating agencies have kept it just above that level because they know AT&T has a flexibility.
In addition to cutting the dividend, AT&T could also rein in capital spending, pegged at around $21 billion on average this year and next according to analysts polled by FactSet, for things like wireless spectrum and aggressive building of the optical fiber. While this could reverse already anemic revenue growth, dividend-focused investors would be protected.
Could things be so bad that even reducing investment wouldn’t be enough? People these days would rather miss rent than give up their cellphones, and most are locked into two-year contracts. But what if customers become more value-conscious due to a recession? AT&T, with Verizon and T-Mobile US,
have a weakening oligopoly. They are losing share to cable companies like Charter Communications and Comcast who offer identical services at a lower price by leasing their networks.
More dangerous is T-Mobile with its acclaimed 5G network and aggressive pricing. A price war between companies whose cost of servicing an additional customer is minimal but whose fixed investments were huge can quickly turn ugly. Think of all those airline bankruptcies.
Investors interested only in the current dividend will likely not regret trusting management this time around. Their real mistake is to focus too much on these quarterly checks. Over the past decade, their total return has been just 6%, according to FactSet, compared to 236% for the S&P 500. None of the other five major dividend payers have beaten the market either. Investors who are confident that AT&T will survive but don’t mind that it is honoring the dividend at the expense of future growth should consider earning a 5% yield on some of its bonds or a 6% yield on his preferred stock instead. Both are superior to common stock in the unlikely event of bankruptcy, and the stock dividend would disappear long before those payments dried up.
Income investing is a lot like signing a phone contract – you really have to read the fine print.
Write to Spencer Jakab at [email protected]
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