Prepared by Stephanie of team BAD BEAT Investing
AT&T (T) stock is on sale in the $27-28 range. Period. Article over. Ok look, we get it. It is frustrating that AT&T has become largely a “zombie” money stock of late. What we mean is that the share price just moves sideways. That is inarguable truth. It is a zombie stock at least with recent price action. We admit, this is not a growth name, but has potential to offer share appreciation. AT&T has been hit hard in multiple lines of business with COVID-19. Putting money into a high-flying growth stock has the potential to generate returns worth much more than the dividend that AT&T pays, but it is a safe dividend and has a place in your long-term portfolio. We know that the debt is a major issue here, but the company is taking steps to address it.
If you have put all your eggs in the AT&T basket, expect to lose. The stock has done nothing since its highly anticipated Q2 earnings report. But that is not such a bad thing when you consider that you should be buying for income. This stock is paying a safe 7.3% yield. That is so attractive for income, but even better for dividend reinvestment and compound interest. Remember exactly what you are buying. This is among the safest 7.3% dividend-yielding stocks on the entire market. You buy AT&T for the dividend and compound growth. There is just no risk to the dividend in the medium term, and we want to make clear that the company is addressing its greatest risk, which is, of course, its debt.
A safe and growing dividend
We were projecting weaker cash from operations than what we saw in a very difficult quarter in Q2. We thought operational cash would come in around $10.2-11.3 billion. But operating cash flow came in well above this estimate, at $12 billion, driven largely by stronger-than-expected revenues. This led to a figure of free cash flow which was strong, and shows us why the dividend is safe. As we consider this dividend payer, or any of them, to be honest, you want to watch free cash flow and the all-important dividend payout ratio.
When Q2 was reported, we were looking for $5.5-6.5 billion in free cash flow, considering capex spending of $4.5-5.5 billion and operational cash of $10-11.5 billion. Free cash flow exceeded our expectations, hitting $7.6 billion, which is strong and better than we expected.
If the pressures we saw in Q2 are the same in Q3 and Q4, then free cash flow could still be a strong $24 billion this year. There is a strong possibility they are even better.
Overall, increasing free cash flow has been a priority for the company, but that goal will be pushed into 2021. However, we see it as improving to end the year. All of that said, the dividend payout ratio tells us why the dividend is safe.
Expect a dividend hike
We like that the dividend is safe, but the dividend is also growing. AT&T has been a serial dividend raiser:
(Source: Seeking Alpha)
We continue to see a $0.04 annual dividend payment per share increase, so free cash flow needs to remain high or show some growth as well to keep the payout ratio safe in the future. The company crushed our expectations for around 60%, coming in at 49%. The dividend is safe. We do fully expect that the dividend will be hiked again in December, and it’s more than covered by free cash flow, even with the pain from COVID-19. So, what does this mean? Well we are looking for free cash flow that comes in at $24 billion for the year, which leads up to project the payout ratio will be 61% for the year. This is a massive improvement from years past. If it comes in higher, we could see a payout ratio in the 50% range. We derive this number by expecting approximately $15 billion in dividends paid out this year, divided by the projected $24 billion (or higher) in 2020 free cash flow.
Debt getting chipped away
We have to say that the debt is often discussed by the bears and those negative on the stock.
One final piece of positive news was that debt declined $2.3 billion from the sequential quarter. AT&T continues to chip away at the debt. Last month, the company announced more early repayment of debt following the acquisition of Time Warner. We estimate debt is just north of $150 billion right now. There is a long path of repayment ahead, but this is substantial progress in less than two years.
WarnerMedia is also cutting costs given the delays in film releases. These cuts will help preserve the balance sheet.
Final thoughts – Buy in the $27-28 range
We will be clear, we still love buying in the $27-28 range. We think that you need to remember why you buy this stock. Some growth in share price is likely as revenue sources rebound. The economy needs to reopen, and WarnerMedia will get a bounce from content. A new phone cycle and 5G will help telecoms. Debt is being paid. AT&T’s payout ratio shows the dividend is safe. This is a great and safe income name.
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Disclosure: I am/we are long T. 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.