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Is AT&T Still a Great Dividend Stock?

By Timothy Green - May 23, 2021 at 7:10AM

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A big dividend cut is coming.

With a deal to merge WarnerMedia with Discovery (DISCA) (DISCK), telecom giant AT&T (T 0.47%) has completed a costly round trip into and out of the media business. AT&T bought satellite TV provider DIRECTV in a $49 billion deal back in 2014, following that up a few years later with an $85 billion deal for Time Warner. By the time the Time Warner deal closed, AT&T had a whopping $180 billion of debt on its balance sheet.

The DIRECTV acquisition was an unmitigated disaster. The company shed pay TV subscribers for years before finally selling a minority stake in the business at a valuation far below what it paid. The Time Warner acquisition brought some valuable assets to AT&T, notably HBO, but combining the two companies never made all that much sense.

The deal with Discovery will turn AT&T back into a telecom company. AT&T will receive $43 billion in the form of cash, debt securities, and the retention of WarnerMedia's debt, while AT&T shareholders will own 71% of the new media company.

By 2023, the new media company is expected to produce revenue of $52 billion and free cash flow of about $8 billion. That's good news for AT&T shareholders. The bad news for AT&T shareholders is that AT&T is using this opportunity to dramatically cut its dividend.

A jar of coins labeled dividends.

Image source: Getty Images.

A big dividend cut

Telecom stocks are traditionally big dividend payers. AT&T's dividend yield right now sits at about 7%. Even though the stock has gone nowhere for years, that high dividend yield provides investors with a nice return.

That lofty dividend was made fragile by the massive amount of debt on AT&T's balance sheet. The WarnerMedia deal will allow AT&T to reduce its debt, but the company is going a step further to make the dividend more sustainable.

AT&T expects to produce annual free cash flow of about $20 billion once the deal is done. The company is targeting a dividend payout ratio of 40% to 43%, so as much as $8.6 billion will go toward paying dividends. That compares to more than $15 billion in dividend payments in 2020.

In other words, AT&T shareholders are going to take somewhere between a 40% and 50% dividend cut. At the current stock price, AT&T's dividend yield would drop to around 3.5% or 4%, depending on the final decision.

Still a solid dividend stock

While shareholders will receive less cash from AT&T each year, the story is now much simpler. AT&T will be a telecom company, and the dividend cut will free up cash for investments in 5G and fiber broadband. Share buybacks are also on the table once AT&T sufficiently knocks down its debt. The company will consider share buybacks once its net debt to adjusted EBTIDA ratio falls below 2.5, which it expects to happen by the end of 2023.

Given that AT&T currently trades for less than 10 times its free cash flow, share buybacks make a lot of sense. A huge dividend is nice, but it may not be the optimal way to return capital to shareholders if the valuation remains low.

And of course, AT&T shareholders will own a piece of a media and streaming giant that will be more capable of taking on Netflix and Disney. Once the deal is complete, AT&T shareholders will own a solid dividend stock plus a growth stock. That doesn't seem like a bad deal to me.

It would have been better for shareholders if AT&T had never tried to build a media empire. But given where the company is now, this deal is the right move. AT&T will be a simpler company with a smaller dividend, but it may turn out to be a better investment in the long run than the complicated, fragile, high-yield mess of the past few years.

Timothy Green owns shares of AT&T. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Discovery (C shares). The Motley Fool has a disclosure policy.

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Stocks Mentioned

AT&T Inc. Stock Quote
AT&T Inc.
$18.12 (0.47%) $0.09
The Walt Disney Company Stock Quote
The Walt Disney Company
$120.18 (2.12%) $2.49
Netflix, Inc. Stock Quote
Netflix, Inc.
$244.59 (0.78%) $1.89
Warner Bros. Discovery, Inc. Stock Quote
Warner Bros. Discovery, Inc.
Warner Bros. Discovery, Inc. Stock Quote
Warner Bros. Discovery, Inc.

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