3 Reasons to Worry About AT&T’s Dividend

A high dividend payout ratio is just one of the reasons investors in this income stock should be worried.

Jul 20, 2014 at 11:00AM

AT&T (NYSE:T) is often thought of as a stock that income investors can buy and put away for years, without having to worry about the company's future. While it's true that AT&T and Verizon (NYSE:VZ) largely dominate the telecom industry, there are new challenges on the horizon. Unfortunately for AT&T investors, several of these challenges would seem to threaten the company's dividend.

Transitions are rarely easy
In management speak, the word "transition" is often used to describe a period of turmoil. Investors don't like hearing the company is going to have a bad year, so management says it is "transitioning" into a better company.

Transitions can take months, or many years, depending on what's going on in the industry. For example, AT&T and Verizon have strong wireless businesses to rely on when things get tough in their wireline businesses, but what about a company like Frontier Communications (NASDAQ:FTR)?

Frontier is in an ever-present transition phase. The company is attempting to move away from traditional landline connections toward high-speed Internet and video services. The strategy seems to be working, as high-speed Internet and video net additions both grew by about 7% annually, and switched access minutes of use dropped by about 8% over last year.

Verizon seems to be content with being the postpaid provider of choice, and reported better than 7% revenue growth in the wireless division. In contrast, AT&T is attempting to transition further into a prepaid provider through the Cricket brand.

On the company's last conference call, management said a big piece of capital expenditures in the near term would be transforming the Cricket network away from CDMA to GSM.

This is the first reason investors should worry for AT&T's dividend. Transitioning customers from devices they have already paid for to new devices, for the sake of the company's network, is a difficult task.

Customers could decide, if they have to get a new device anyway, that perhaps another carrier makes more sense. With "70% of Cricket customers use(ing) smartphones," this is no small issue. If AT&T sees lower growth in prepaid connections, or experiences losses, this could cut into the company's cash flow, threatening the dividend.

This was supposed to solve the problem, right?
The second threat to AT&T's dividend is the move in the postpaid wireless market away from subsidies and toward installment plans for phones. With wireless providers subsidizing smartphones at a rate of about $400 per phone, in theory, installment plans would help AT&T and Verizon avoid this huge upfront cost.

However, it may not work out that way. First, customers have been willing to go on an installment plan for their phones, but only if the monthly price is cheaper than on contract. What happens is AT&T accepts a lower monthly price so that customers pays for their phones. The problem, of course, is the longer customers keep their phones, the less profitable they are relative to an on-contract customer.

The second part of the problem is these phones are not free. When AT&T sells direct, the company must purchase the phone from the manufacturer. On a $600 phone, the installment plan might be $30 per month for 20 months. Needless to say, spending $600 up front to get it back over an almost-two-year period will have a direct effect on AT&T's cash flow. Getting lower monthly income from these plans will certainly hurt the company's cash flow as well.

The ultimate question
The third reason to worry about AT&T's dividend is the fact that the payout ratio doesn't look good relative to the company's peers. In fact, if this were a different company, analysts might already be speculating about a dividend cut.

In its last quarterly results, AT&T's core free cash flow (net income + depreciation – capex) payout ratio was 92%. In comparison, Frontier (which already cut its dividend) has a free cash flow payout ratio of 54%, and Verizon's payout is even lower at 25%.

With AT&T predicting roughly $11 billion in free cash flow for 2014, at the current dividend rate, the payout percentage would be 87%. Of course, this assumes that AT&T can generate four quarters like the first quarter of this year.

Final thoughts
If the Cricket transition doesn't go according to plan, or the move away from subsidies doesn't play out as expected, AT&T's cash flow may come in lower. What happens when a company with a relatively high payout ratio also faces potential cash flow challenges? I would suggest investors don't stick around to find out.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

 

Chad Henage owns shares of Verizon Communications. The Motley Fool has no position in any of the stocks mentioned. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers