AT&T (NYSE:T) has gotten a lot bigger over the last couple years. After successfully acquiring DIRECTV and Time Warner, now WarnerMedia, the wireless giant is now a cable media giant, too. AT&T is the second-largest wireless carrier in the U.S. after Verizon Communications (NYSE:VZ). It also currently boasts the largest video subscriber base when you combine its U-Verse, satellite, and streaming businesses. And its collection of media networks and film studio under WarnerMedia is one of the best in the industry.
With shares trading at historically low valuation levels, investors may see an opportunity to buy a stock with stable cash flow and a strong record of returning capital to shareholders. AT&T's 6.3% dividend yield is quite high, and AT&T has raised it every year for 34 consecutive years. Is AT&T a good low-risk dividend investment?
AT&T's competitive advantage
A good company for investment has a strong competitive advantage that can protect its profit margin and its cash flow. For AT&T, its biggest advantage is its scale.
In wireless, which requires very high fixed costs to build a cellular network, AT&T can spread its cost across a lot more customers than smaller competitors like T-Mobile (NASDAQ:TMUS) and Sprint (NYSE:S) can. That allows the company to produce much higher profit margins and greater returns on invested capital.
AT&T's wireless EBITDA margin is consistently in the high 30% to low 40% range. Verizon's wireless EBITDA margin is in the mid-to-high 40% range. Comparatively, T-Mobile and Sprint produce EBITDA margins in the mid-to-high 20% range.
AT&T experiences the benefits of scale to a lesser degree from its satellite TV business, which has some fixed costs as well. But variable costs for servicing each customer, including installation and ongoing licensing expenses, don't produce the same margin protection.
The media business certainly experiences benefits of scale since it costs the same to produce a series or film regardless of how many people pay to view it. But WarnerMedia isn't any bigger than other big cable media companies.
AT&T has a moat around its wireless business -- its largest segment -- but its other businesses aren't as well-positioned.
The competitive environment
The wireless industry has been fiercely competitive lately, but the proposed merger between T-Mobile and Sprint could calm the waters. Both of the smaller carriers have been aggressively pursuing more customers in order to achieve the benefits of scale both AT&T and Verizon possess. If the two companies merge, they may become less aggressive since the new entity would have similar scale to AT&T and Verizon.
Meanwhile, AT&T faces a tough situation in pay TV. While it's starting to add subscribers once again, thanks to its DIRECTV Now streaming service, those subscribers are coming at a much lower margin. The EBITDA margin on its entertainment group segment has fallen from 24.2% to 20.7% over the last two years. Time Warner saw declining operating margin in 2017 as well as its cost of content increased at Turner and HBO, but revenue didn't keep pace.
Cord-cutting continues to weigh on the pay TV and media business. As the trend accelerates in 2018, AT&T will have trouble growing revenue from its pay TV subscription business as well as WarnerMedia affiliate fees.
One thing that should irk AT&T investors
After acquiring DIRECTV and Time Warner (and several other smaller companies), AT&T has racked up a hefty amount of debt. While it's unlikely AT&T will default on its debt given its considerable cash flow, paying the principle and interest on $180.4 billion in debt will eat up quite a bit of cash every quarter.
What's more, the Time Warner acquisition added 1.185 billion shares outstanding for AT&T. Paying the annual dividend on those shares will cost another $2.4 billion in cash annually at the current dividend rate. That brings the total dividend payment to about $14.6 billion.
With the high level of debt and new shares outstanding, AT&T may continue the trend of extremely low dividend increases just to maintain its 34-year streak. But if it faces any unexpected challenges in any of its main businesses -- wireless, pay TV, and media -- investors could see negative consequences in the capital return program. Considering the competitive intensity it faces in all three areas, it's a real possibility.
Is AT&T a buy?
AT&T currently trades for a price-to-free-cash-flow ratio of just 10.84. That's a valuation the stock hasn't seen since 2013.
That said, AT&T isn't growing very much. The acquisition of Time Warner puts it in a position to reduce costs for its pay TV segment by reducing the costs for negotiating licensing agreements, but the move doesn't provide any real revenue synergies. Investors shouldn't expect much growth from the company's top line over the next few years, as competition in the wireless industry remains fierce and replacing legacy linear TV subscribers with DIRECTV Now subscribers that bring in less revenue will put pressure on the top line in the entertainment segment.
I think AT&T's debt and its positions in the highly competitive wireless market and declining pay TV market make the company unattractive. Even at such a low stock price, I wouldn't buy it. Investors that believe AT&T's cash flow will more than cover its debt obligations and provide enough capital to return to shareholders may take the opportunity to lock in a 6.3% yield.