The day will come when the man at the telephone will be able to see the distant person to whom he is speaking.
– Alexander Graham Bell –
During the COVID-19 pandemic, if you have noticed AT&T stock because of its falling price and whopping 8% dividend yield, you are not the first one. We have noticed it too. In fact, we got so deeply interested in it that we have initiated position in AT&T.
Here is what we have seen. As candid as it could get.
Is AT&T Dividend Safe?
The two things could derail the AT&T dividends.
- Interest Rate
- Falling Revenue
Currently, AT&T has $173 billions long Term Debt and it pays $8.4 billion in interest. The current average interest rate is 4.4%. This is not so bad, since the interest rate is bottom low. We don’t expect this to continue for forever. Once the interest rate goes up and if the debt load stays at that level, AT&T will have hard time paying interest and it will be forced to cut dividends.
| FY19 | TTM | Y-Y Growth | |
| Operating Cash Flow | 48.6 | 44.9 | -8% |
| CapEx | 16.8 | 16.8 | 0% |
| Dividends | 14.9 | 14.9 | 0% |
| Interest | 8 | 8.4 | 5% |
| Tax | 3.4 | 4.9 | 44% |
Generally, AT&T increases dividend around this time each year. This year, it didn’t. Their cash flow is tight, which brings us to #2.
Due to COVID-19 and falling traditional DIRECTV and U-Verse subscribers, AT&T is suffering revenue decline, which has decreased their Net Income and Free Cash Flow. If this trend does not reverse or stabilize, AT&T’s dividend is at risk.
AT&T has $9.8 billion cash in the balance sheet, which is not enough to pay dividends for this year; however, including the future cash flow, it will be enough. Since it still has positive cash flow.
With the competition in 5G network, AT&T should buy broadband from the US Government, which requires deep pocket. AT&T is preserving some cash for that by not increasing dividend this year.
We can firmly conclude that this year the dividend is safe. Albeit, it is not guaranteed for next year, which depends on the above two variables.
Growth
AT&T’s communication sector is still strong; its growing. However, the DirectTV is dragging the revenue down. The new CEO, John Stankey, is trying to offload that segment and, currently, the rumor is that they are getting offers above $15 billion for that segment.
With the leadership of Randall Stephenson, in 2015, AT&T purchased DirectTV for $48.8 billion.
In 2016, AT&T purchased Time Warner for $108.7 billion in an effort to increase its media holdings.
In 2020, after all these shopping spree, its Goodwill has ballooned to $146 billion from $69 billion in 2014 and its Long-Term Debt has ballooned to $173 billion from $76 billion in 2014. Thanks to Randall Stephenson’s vision and ego to be the CEO of the debt loaded failing conglomerate.
| FY19 | TTM | Y-Y Growth | |
| Revenue | 181 | 172 | -5% |
| Operating Income | 29.4 | 26 | -12% |
| Operating Margin | 16% | 15% | -7% |
| Net Income | 13.9 | 10.9 | -22% |
| Net Margin | 8% | 6% | -17% |
In contrast, Verizon is doing far better than AT&T in maintaining their total revenue. Also, they have far better Operating Margin and Net Margin.
| FY19 | TTM | Y-Y Growth | |
| Revenue | 131 | 128 | -2% |
| Operating Income | 30 | 28 | -7% |
| Operating Margin | 23% | 22% | -4% |
| Net Income | 18 | 19 | 6% |
| Net Margin | 14% | 15% | 8% |
Profitability
AT&T’s profitability is bad. Verizon’s profitability is far better than AT&T. They have 15% ROIC and 31% ROE. To add salt in the wounds – T-Mobile have better profitability ratios than AT&T!
Given the cost of debt capital of 4.4%, ROE of 5.4% is pretty low. Their ROIC and ROA is below their Cost of Capital. Theoretically, they are better off to close their shops, if the dire situation of net profit does not go up.
| Profitability | FY19 | TTM | Y-Y Growth |
| ROIC | 4.2% | 3.1% | -24% |
| ROA | 2.6% | 2.0% | -24% |
| ROE | 7.2% | 5.4% | -25% |
Honestly, we do not prefer to hold this type of mediocre companies for a long term.
Valuation
The final topic of our analysis is valuation. If we look at the valuation metric by itself, its pretty good. However, if we look at that in conjunction with growth, its not so much. If the falling free cash flow accelerates, the current fair valuation will suddenly look foolish.
| Valuation | FY19 | TTM | Y-Y Growth |
| Price/FCF | 9.8 | 8.0 | -18% |
| Price/OI | 5.9 | 5.0 | -15% |
| Price/Earning | 20.5 | 20.6 | 0% |
| Dividend Yield | 5.2% | 6.7% | 27% |
Hope or Strategy?
Nevertheless, there is some hope!
The following development have given us some hope.
- New management.
- HBO Max streaming service
The new CEO, John Stankey seems levelheaded (see who is talking!). He has already taken steps to reduce debt, offload the failing DirectTV segment and streamline the core segment. We do not know how that will pan out, but we will wait and see.
Time Warner does have one of the best media contents, but its failing to cater those to the Netflix generation. Understanding the ground reality, AT&T has launched HBO Max streaming service and its gaining some ground now.
In 2020, it is planning to have 36 million paid subscribers. In comparison, Netflix and Disney+ have 193 million and 86 million subscribers respectively.
AT&T does not have a big market-share, but it is a good start. We believe the falling subscribers in Direct TV segment will be finally be muted by HBO Max.
Better yet, DirecTV will go away bringing in the most needed cash and HBO Max will write a new chapter in AT&T’s history.
The probability of happening that is very slim, but there is a hope.
Our Position
May be we are really early in celebrating success.
Our holding is up around 10% already and dividend yield of 8% at our purchase price puts us at 18% year one return. Obviously, the price will fluctuate. We will be more than happy if it goes up. Also, we are prepared to walk out with only 8% dividends or perhaps loss.
It is a waiting game. ‘Game of Thorn’ like HBO Max series will certainly aid to our waiting game.
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