Most investors own U.S. telecom giant AT&T (T -1.37%) for its large dividend that yields 6%. But should investors worry about whether the company can afford that payout when times get tough? A recession can squeeze consumers, and rising interest rates are prohibitive for companies with a lot of debt. Borrowing or refinancing becomes very expensive.
I'll break down the company's debt load to see how much debt is due in the coming years, and determine whether a recession is a cause for worry or if it's just hot air.
The dangers of debt
AT&T had quite a journey over the past decade, acquiring DirecTV and Time Warner to build pay television and streaming businesses. These were huge deals worth tens of billions of dollars, and AT&T funded them using a lot of debt. The company's since abandoned its entertainment projects and is back to functioning as a pure-telecommunications business.
Unfortunately, the scars of these deals still haunt investors and the company's balance sheet. AT&T still has a whopping $123.8 billion in long-term debt. That's down from $151 billion at the end of 2021, thanks mainly to a cash infusion from spinning off Time Warner earlier this year. Progress is great, but there's more work ahead. The company's balance sheet still carries a high debt-to-EBITDA ratio of 3.2 after subtracting AT&T's cash on hand.
Too much debt is financially dangerous for a business. Rising interest rates make that debt more expensive to refinance, and the interest payments take away from a company's cash profits. AT&T's large debt load is worth scrutinizing in the current economic environment.
Digging into the debt details
AT&T's debt could tell a lot about whether investors should fear another dividend cut. Management believes that free cash flow for 2022 will come in at $14 billion. That means potentially $6 billion in free cash flow in the fourth quarter after doing $8 billion through nine months. Subtract almost $2 billion for the dividend and add the existing $2.4 billion already on the balance sheet, and AT&T should have roughly $6.4 billion in cash at the end of 2022.
The company has approximately $9.6 billion in debt due over the next year, but remember that AT&T will produce more free cash flow throughout 2023. Hypothetically, AT&T isn't a fast-moving business, so investors could look for somewhere around the $14 billion management expects this year, meaning another $6 billion left after the dividend. Cash flow might vary quarter to quarter, but it looks like AT&T can pay off its upcoming bills.
AT&T's debt schedule disclosure shows about $8.3 billion due in 2024. Again, that should be manageable if the business keeps performing, but it might be tight. Therefore, investors probably shouldn't expect big dividend increases or major money moves soon. Investors should follow management's guidance as time passes to see what cash flow looks like.
Taking a long-term view
Ultimately, AT&T seems locked into its current position as a pure-telecom company that's stuck paying off its bills for the foreseeable future. Rising rates could make refinancing unattractive, so management could pay down its notes as they come due. But that's not necessarily bad for investors. Less debt makes AT&T a healthier and more reliable dividend stock. Plus, AT&T's subscriber growth shows that it's thriving at what it does best -- running its wireless business.
The stock probably won't excite your portfolio, but investors shouldn't sneeze at a seemingly reliable 6% dividend yield. The debt has likely played a role in weighing down the stock's valuation, which sits at a price-to-earnings ratio (P/E) of 7, just over half of its decade-long median P/E of 13.
AT&T's interest expense was $6.3 billion over the past four quarters. Paying that down will push that money to the bottom line, which could support an eventual higher valuation for the stock.
