A streak of annual payout hikes has helped to make AT&T (T +0.42%) a high-yield dividend stock. Moreover, the excitement of 5G contributed to a 37.1% rise in the stock price during 2019.
However, shares have fallen so far in 2020. Competition and massive capital spending have worried investors. This may leave investors wondering if AT&T stock can soon return to growth, adding share-price appreciation to the returns it gives investors in the form of lucrative dividends?
AT&T's dividend may look solid at first glance. The company's long history of phone and internet services has given the company a dividend that has increased every year for the last 35 years. The $2.08 per share annual payout in dividends yields 5.5%. Moreover, assuming the merger of T-Mobile (TMUS +0.28%) and Sprint (S +0.00%) occurs, it will make AT&T just one of three companies that will offer nationwide 5G service in the United States. Due to the massive cost of the 5G buildouts, neither Verizon (VZ 0.40%) nor T-Mobile will likely have the appetite for the price wars of the 3G and 4G eras.
But some investors may be spooked by AT&T's payout ratio -- the percentage of net income allocated to the dividend. The key ratio has risen to 108.5%, leading to concerns about the future of AT&T's payout. This compares to a manageable 52.47% for Verizon.
Image source: Getty Images.
AT&T has struggled to stay relevant
AT&T stock has experienced pain in many areas besides price wars. Cord-cutting decimated a once-profitable pay-TV business. Moves such as its purchase of DirecTV for $67 billion (including debt) at its peak have left it with massive obligations. The total debt has risen to $184.95 billion, a level not that far below the market cap of just over $265.1 billion.
Moreover, this blue-chip company has had to spend tens of billions to build a 5G to keep itself relevant in the communications business. Across the world, analysts expect almost $1 trillion in worldwide 5G infrastructure costs between 2019 and 2025.
Yes, both Verizon and T-Mobile also face this cost. However, Verizon, the only other dividend payer, took more of an "all-in" strategy on 5G, foregoing the media ventures of AT&T. This means the $240 billion company has a more manageable debt level of $133.14 billion. Despite its lower 4.1% dividend yield, the lower debt makes this a safer dividend.
However, with the declining value of pay-TV products, AT&T's foreseeable future also depends primarily on the success of 5G. Regardless of how much AT&T focuses on non-5G assets, the company is essentially all-in on 5G from an investor standpoint. The fact that Verizon is more up-front about this fact gives it the advantage.
AT&T's stagnant stock price
For much of the latter 20th century, AT&T stock climbed steadily. This changed following the dot-com bust as investors sold stock and the nature of telecom began to make dramatic changes. As a result, AT&T still trades at levels it first saw in 1998!
It does not help that the century ushered in the decline of a once-reliable source of cash flow, the landline. The rise of streaming media in the 2010s encouraged a rash of cord-cutting on its pay-TV products. Streaming services such as Netflix, Amazon, Disney, and many others have induced millions to cut the cord.
The (remaining) case for AT&T stock
However, the financial condition of AT&T and the stock's decline so far in 2020 could entice investors. Despite the increases it saw in 2019, the forward P/E ratio stands at around 9.7.
Also, while the current dividend exceeds net income, the company produced enough free cash flow in the previous quarter, $8.191 billion, to meet the quarterly dividend obligation of $3.726 billion. Moreover, over time, the payout ratio should come down. The previous annual dividend increase from $2.04 per share to $2.08 per share amounted to a 1.96% increase. Wall Street forecasts average yearly profit growth of 4.90%, pointing to an anticipated gradual reduction in the payout ratio over time. For these reasons, AT&T appears to have a safer payout than the dividend payout ratio would indicate.
Interestingly, the stock's consistent dividend increases may help make this dividend safer. Dividend aristocrats, stocks with annual dividend increase streaks of at least 25 years, tend to continue their payout hikes.
Of course, any company that ends annual payout hikes could face short-term, and possibly even long-term, selling. Former dividend aristocrat Bank of America suffered for years after payout cuts. General Electric continues to struggle since it cut its dividend. Given the stock's underperformance over the past two decades, management probably does not want to give investors an additional reason to sell AT&T stock. If the company can maintain its dividend streak, it more than likely will.
AT&T should benefit as more customers adopt 5G. The lack of competition should give AT&T, Verizon, and T-Mobile significant pricing power.
Furthermore, the company has contemplated selling DirecTV. While that would mean it loses DirecTV, it would enable AT&T to unload a money-losing unit and give the company some capital to pay down its debt.
Consider AT&T stock
AT&T's dividend should remain safe. Given the potential of 5G and a high-yielding, growing dividend, AT&T stock may appeal to income-oriented investors at first glance. However, the decline of once-stable business units, as well as the cost of building out 5G, has hurt this company. During this time, the pressure of maintaining a dividend streak squeezed AT&T.
However, the beginning of 5G could give AT&T pricing power it has not seen in years. Additionally, if it sells assets such as DirecTV, it would have an opportunity to lower debt to more sustainable levels.
