Telecommunications company AT&T (New York Stock Exchange:T) has historically attracted investors with its mature business model characterized by low volatility and high dividend yield backed by strong cash flows. Despite lacking strong growth prospects, the company consistently pays consistent dividends with relatively low risk.
The last few turbulent years have belied these strengths, but AT&T has since reorganized itself by focusing on its core business. It is poised to continue generating strong dividends in the years ahead, which is why I remain bullish on the company.
T’s dividend yield remains very attractive
AT&T has been a consistent dividend payer since the company went public in the 1980s, establishing itself as a benchmark in dividend investing for decades.
However, starting in 2022, the company made a major quarterly dividend cut of nearly 50%, reducing it from $0.52 to $0.28, marking the end of a 35-year streak of dividend increases for AT&T. . The decision was necessary due to the company’s high debt levels, which reached approximately 3.6 times net debt to EBITDA, mainly due to two large acquisitions that were ultimately unsuccessful (DirecTV and Time Warner) that resulted in substantial losses. .
As shown in the chart below, AT&T’s dividend yield trajectory has declined sharply since 2021. The company currently offers a yield of around 6% (with a payout ratio of 47% of its earnings), significantly higher than the telecommunications sector average of 2.5. % and well above the PCE inflation rate of 2.7%. Despite the recent pullback, AT&T remains a compelling alternative to income stocks.
Dividend security: management unlikely to let shareholders down
Over the past two years, AT&T’s investment thesis has taken a hit, raising questions about its sustainability. However, since 2022, the company has reported stable quarterly dividends.
In 2023, AT&T generated $20.46 billion in free cash flow (FCF) and paid $8.13 billion in dividends, implying that only 39% of FCF was used for dividends. This suggests that the company has substantial room to maneuver if its cash flow declines, potentially avoiding dividend cuts, a reduction in corporate reinvestment, or an increase in debt.
This is a significant improvement compared to 2022, when 77% of its free cash flow was allocated to dividends. It is important to note that in 2022, AT&T’s cash flows were negatively impacted by specific operations. The year marked a strategic shift to focus on its core telecommunications business, including the completion of the WarnerMedia spinoff. This divestiture reduced AT&T’s revenue and cash flow from media operations, impacting overall free cash flow.
In addition, AT&T significantly increased its capital expenditures by investing in 5G infrastructure and expanding its fiber network. These investments, while crucial to maintaining competitiveness, resulted in higher immediate cash outflows, which reduced free cash flow in the short term.
With cash flows normalizing in 2023, dividend payments are likely to remain stable for years to come. AT&T’s ability to reduce debt and target a leverage target of 2.5 times (net debt to EBITDA) by the first half of 2025 further supports this stability.
CEO John Stankey’s comments during AT&T’s latest quarterly earnings conference call indicate that management is taking a flexible approach to dividends.
They plan to adjust their dividend yield to align with prevailing economic conditions, saying: “We are very conscious of the desire to ensure that we are treating our shareholders well. At that point we will evaluate where things like interest rates are. “We will assess where we are in terms of dividend yield relative to equity value and where we have opportunities to reinvest in the business.”
The valuation is relatively discounted
On the valuation side, AT&T’s forward price-to-earnings (P/E) ratio of 8.3 times is nearly in line with that of Verizon (New York Stock Exchange:VZ) 8.7x in the US. However, it is much lower than that of T-Mobile (NASDAQ:TMUS) 19x. Internationally, its forward P/E remains lower compared to Vodafone’s (NASDAQ:VOD) 24.2xy America Movil (New York Stock Exchange: AMX) 11.6x.
Unlike its domestic peers, AT&T’s strategy remains focused on its core business operations, while Verizon and T-Mobile pursue strategies based on mergers and acquisitions (M&A) and new product lines. While this conservative approach may limit AT&T’s growth relative to its peers, it enhances the attractiveness of its dividend thesis.
Despite minimal growth estimates for AT&T through the end of 2024, with an expected increase of less than 1% in its top line, the company’s management sees AI as an excellent opportunity for the telecom. AI can help AT&T reduce costs, accelerate deleveraging, and boost EBITDA growth by offering enhanced services to its customers.
Are AT&T stocks a buy, according to analysts?
Wall Street sentiment towards AT&T stock is predominantly bullish, with the consensus among 12 analysts rating it a Strong Buy. Only three analysts have a Hold rating and none are bearish. The average price target for AT&T stock among analysts stands at $21.50, indicating a 14.7% upside potential for the company.
The bottom line
After the turbulent period of the past four or five years, AT&T now appears to be in a stable position and poised to continue delivering attractive returns to its shareholders. The company’s strategy is focused on its core telecommunications business and deleveraging away from ambitious M&A, and it trades at a discounted valuation compared to its peers.
Furthermore, AT&T management appears committed to maintaining dividend yields at attractive levels, reflecting its dedication to shareholder value. This stabilization, coupled with the company’s strategic focus and financial discipline, positions AT&T favorably for inclusion in a portfolio of high-quality dividend-generating stocks.
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