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Should You Buy AT&T for Its 7% Dividend Yield?

By Leo Sun - Apr 23, 2020 at 11:40AM

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This Dividend Aristocrat’s yield is hovering near all-time highs.

AT&T (T 1.84%) recently posted weak first-quarter numbers, and pulled its forward guidance in light of the COVID-19 pandemic. The telecom and media giant's revenue fell 5% annually to $42.8 billion, missing estimates by $1.4 billion.

Its non-GAAP earnings dipped 2% to $0.84 per share, also missing expectations by a penny. Excluding the impact of COVID-19, which reduced its earnings by about $600 million, its EPS would have risen 3% to $0.89.

On their own, those numbers look dismal. However, many investors might be eyeing its forward yield of nearly 7%, which the company remains committed to paying. Should investors buy AT&T for that beefy dividend, or are its weak spots too soft to ignore?

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Image source: Getty Images.

What's wrong with AT&T's business?

Prior to the pandemic, AT&T faced two major headwinds: the sluggish growth of its wireless subscriber base and its ongoing loss of pay TV subscribers at DirecTV and U-verse. Its $85 billion takeover of Time Warner, which was closed in mid-2018, was aimed at diversifying its business beyond those segments and bolstering its streaming media capabilities.

However, AT&T's streaming plans, which include AT&T TV, AT&T TV Now (formerly DirecTV Now), WatchTV, HBO Now, HBO Max, and DC Universe, have been messy and fragmented. AT&T spent billions of dollars to secure hit shows like Friends and The Big Bang Theory, but it's unclear if those investments will pull viewers away from Netflix, Disney+, and other established streaming services.

A couple shares popcorn in a movie theater.

Image source: Getty Images.

Meanwhile, the pandemic forced Time Warner, now known as WarnerMedia, to delay major movie releases like Wonder Woman 1984 and The Batman. AT&T had counted on that box office revenue to boost its free cash flow in 2020 as it expanded its loss-leading streaming business.

Those headwinds forced AT&T to rely more heavily on the mobility unit of its communications segment. The mobility division actually performed well during the first quarter, with 163,000 postpaid additions and a postpaid churn rate of just 0.86%, which lifted the unit's service revenue by 2.5% and its operating profit by 9%.

Unfortunately, that growth couldn't offset the weakness of WarnerMedia, which posted a 12% annual drop in revenue with a 26% decline in operating profits. The weakness of its pay TV, legacy wireline, domestic wireless equipment, and Vrio (the Latin American branch of DirecTV) businesses exacerbated that pain.

But what about its dividend?

AT&T has hiked its dividend annually for 35 straight years. That streak makes it a Dividend Aristocrat of the S&P 500 -- a member of the index that has raised its payout for at least 25 straight years. Dividend Aristocrats are considered top investments for income investors, so AT&T won't cut its dividend unless it faces severe liquidity issues, which shouldn't occur anytime soon.

In the first quarter, AT&T spent $3.7 billion of its $3.9 billion in free cash flow on its dividends, which gives it a cash dividend payout ratio of 95%. That ratio might seem high, but AT&T believes it will decline throughout the rest of 2020.

During the conference call, CEO Randall Stephenson estimated AT&T's cash dividend payout ratio for 2020 would remain in the low 60s, compared to just over 50% in 2019. Stephenson also declared AT&T remained "committed" to its dividend, and reminded investors that AT&T had weathered "a lot of other crises before." AT&T already suspended its buybacks in late March, which should free up more of its FCF for dividend payments and the gradual reduction of its long-term debt.

In short, AT&T's dividend remains safe, and its 7% yield is significantly higher than Verizon's (VZ -2.17%) 4.3% yield. However, Verizon is also more resistant to COVID-19, since it doesn't own a massive, pandemic-impacted media subsidiary like WarnerMedia.

A safe dividend, but not much else

AT&T trades at just nine times forward earnings. That valuation could rise as analysts cut their forecasts, but its high yield should also set a floor under the stock. Therefore, AT&T remains a fairly safe income investment for conservative investors.

However, investors shouldn't expect AT&T's stock to rally anytime soon, since it will keep losing pay TV subscribers as the pandemic sidelines its new media businesses. But if AT&T finally gets its act together, those new growth engines could finally convince investors to pay a premium for this dusty old dividend stock.

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Stocks Mentioned

AT&T Inc. Stock Quote
AT&T Inc.
T
$20.99 (1.84%) $0.38
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
VZ
$50.96 (-2.17%) $-1.13

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