Is AT&T, Inc.'s Dividend Growth Safe?

AT&T distributes a high percentage of its free cash flow. But its DIRECTV acquisition and other financial management moves should pave the way for decent dividend growth going forward.

Jul 10, 2014 at 7:00PM

AT&T (NYSE:T) is a company on the move. While investors might instinctively think of AT&T as a lumbering giant because of its massive size, it's still got plenty to offer. It's likely most investors flock to telecommunications giants like AT&T for its hefty dividend. Indeed, AT&T yield clocks in at a robust 5.2% -- far higher than most other stocks. In fact, AT&T's dividend stands even higher than that of its closest rival, Verizon Communications (NYSE:VZ).

But AT&T isn't sitting still. It's pursuing strategic initiatives that should provide it plenty of growth to keep rewarding shareholders with big dividends. To that end, it's about to take over satellite TV provider DIRECTV (NASDAQ:DTV).

And, fortunately, AT&T isn't sitting idly by while its balance sheet bloats with debt. It's taking proactive steps to effectively manage its financial position. If investors are scared of AT&T's debt load impacting its ability to pay its high dividend, here's why those fears are overblown.

Is AT&T's debt a major concern?
AT&T announced it will acquire DIRECTV in a massive transaction valued at $67.1 billion, including debt. To help finance the deal, AT&T recently conducted a sizable debt offering. The company sold $2 billion in long-dated bonds.

It's reasonable for investors to be concerned about AT&T's balance sheet, particularly now that it plans to absorb DIRECTV. After all, AT&T already held $71 billion in long-term debt at the end of its most recent quarter. Its financial position will be further strained by the massive acquisition and ensuing debt sale.

But it's important to note that AT&T's debt sale was done at extremely attractive rates. Thanks to interest rates remaining near historic lows, AT&T actually took advantage of a favorable environment. It offered 30-year bonds that yield just 1.4 percentage points more than similarly dated U.S. Treasury bonds, for a yield around 4.8%. That's lower than AT&T's dividend yield, so it made more sense to raise funds by selling debt than through an equity offering.

In addition, AT&T is raising funds by selling its 8.3% stake in Latin American phone company America Movil SAB (NYSE:AMX). Billionaire Carlos Slim announced he would buy AT&T's investment in his company for $5.57 billion. This will provide AT&T even more financial flexibility to cushion the blow from the DIRECTV acquisition.

An important caveat is that AT&T was already in a solid financial position, generating strong free cash flow. Here are some of AT&T's most important financial metrics, and how they stack up against Verizon's numbers:

 

Dividend Yield

Long-Term Debt to Equity Ratio

Free Cash Flow Payout Ratio

AT&T

5.2%

78%

70%

Verizon

4.3%

777%

39%

FCF source: 2013 Annual Reports

As you can see, AT&T's hefty dividend is well-supported by sufficient underlying cash flow, and its long-term debt isn't overly burdensome. That's especially true when you evaluate AT&T's debt load in the context of its peers. Verizon's long-term debt has exploded over the past few years.

Verizon has $107 billion in long-term debt, up hugely from just $17 billion two years ago. It's taking on huge amounts of debt to expand its network and infrastructure.

What the future holds for AT&T's dividend
AT&T has increased its dividend by about 2% compounded annually over the past five years, which might not sound like much, but it's roughly on par with inflation. That means investors are not only getting a nice payout, but the purchasing power of those dividend payments will be protected by AT&T's reliable dividend growth.

Future dividend growth should be in line with the recent past for AT&T. It recently increased its full-year revenue outlook, and it will realize significant synergies from the DIRECTV acquisition. Those should provide a boost to profitability and cash flow. However, it's also true that AT&T has a lot of debt on the books, without much flexibility available since it's already paying out a significant majority of its free cash flow.

The bottom line is that AT&T's dividend is secure, and shareholders should expect 2%-3% annual dividend growth from AT&T over the foreseeable future.

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Bob Ciura owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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