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Is AT&T Stock a Buy?

By Leo Sun – Aug 6, 2020 at 12:45PM

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The telecom giant pays big dividends, but its stock has been stuck in a rut for years.

AT&T (T -0.89%) is often considered a stable dividend stock for conservative investors. It's established a wide moat as one of America's top telecom companies, it pays a forward yield of nearly 7%, and its stock trades at just nine times forward earnings.

However, AT&T has also delivered underwhelming returns over the past five years. Its stock declined more than 10% as the S&P 500 rallied nearly 60%. Even after reinvesting its dividends, AT&T's total return of 14% still underperformed the market.

Bull and bear figurines.

Image source: Getty Images.

Past performance isn't a reliable benchmark for future gains, but AT&T's tepid track record is likely keeping the bulls away. AT&T's stock looks cheap and its dividend could limit its downside potential, but is it worth buying?

The bear case against AT&T

AT&T faces several tough challenges. First, sluggish sales of smartphones, competition from rivals like Verizon, and COVID-19 closures of retail stores all hurt its core wireless business in the first half of the year.

Second, cord cutters are gutting its pay TV business, which lost nearly a fifth of its subscribers year-over-year last quarter. Its DirecTV, U-verse, and AT&T TV platforms are struggling against stand-alone streaming rivals like Netflix, and the streaming services it launched after its takeover of Time Warner last year -- including HBO Max and AT&T TV Now -- aren't offsetting those losses yet.

A woman eats popcorn while watching a movie on her laptop.

Image source: Getty Images.

Meanwhile, the COVID-19 pandemic hurt WarnerMedia by postponing its production and releases of new TV shows and movies. To make matters worse, AT&T's attempts to unify its fragmented streaming services often confused and frustrated consumers. Analysts expect those headwinds to reduce AT&T's revenue and earnings 7% and 10%, respectively, this year.

AT&T is also shouldering a lot of debt, due to its acquisitions of DirecTV, Time Warner, and AWS-3 spectrum licenses. It reduced its long-term debt less than 3% annually to $153 million last quarter, but its free cash flow slid 14% to $7.6 billion. AT&T divested some of its non-core businesses and temporarily suspended its buybacks earlier this year, but its free cash flow could continue sliding and limit its ability to reduce its debt.

All those challenges could make it tough for AT&T to maintain its current dividend payments -- which rose 11% to $14.9 billion last year -- without reducing its long-term credit rating.

The bull case for AT&T

Those headwinds seem fierce, but there are flickers of hope on the horizon. AT&T's wireless business is still growing, with an 8% annual increase in subscribers last quarter, and the launches of new 5G phones later this year could boost its average revenue per subscriber again.

AT&T's streaming and WarnerMedia efforts look messy right now, but the company is gradually breaking down the silos and eliminating redundant services like HBO Go and Watch TV. It also hired Hulu's former boss to unify its streaming efforts, and secured the rights to popular series like Friends and The Big Bang Theory. The unit's growth should also accelerate again as theaters reopen and it resumes the production of suspended projects.

AT&T's debt levels look high, but only $15.6 billion of that total matures within a year. AT&T should easily cover those payments and still have enough cash for its dividend. After all, it only spent 57% of its free cash flow on its dividend over the past 12 months.

Furthermore, AT&T's 36 straight years of dividend hikes makes it a "Dividend Aristocrat" of the S&P 500, an elite title bestowed upon companies that have raised their payouts for at least 25 straight years. It's highly unlikely AT&T will give up that title, even if its earnings continue to decline or it's threatened with a credit ratings cut, since many investors only own the stock for its dividend.

Should investors buy AT&T?

AT&T faces plenty of near-term challenges, but I believe its dividend is safe and its stock should recover as the longer-term tailwinds kick in. AT&T has been a lackluster investment in recent years, but investors should realize the aging telecom giant is transforming -- and those changes could generate much stronger returns over the next few years.

Leo Sun owns shares of AT&T. The Motley Fool owns shares of and recommends Netflix. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.

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*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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