Popular dividend stock AT&T (T -0.59%) shook investors when its recent earnings report revealed a plunge in cash profits from the previous year. The market responded by sharply selling shares lower.
Investors wonder whether AT&T's dividend is safe after management already cut it once as part of spinning off its media business last year. After all, what good is a 6% dividend yield if you can't rely on it?
Rather than panic, read below to find out what should and shouldn't have investors worried about AT&T moving forward.
Should investors worry about the dividend?
The most shocking tidbit from AT&T's first-quarter results was its minuscule free cash flow. The company generated just $1 billion in cash profits, down from $2.8 billion the prior year. That's a big problem because AT&T pays out roughly $2 billion each quarter in dividends, meaning it could afford only half its dividend in Q1.
But this is a case in which reading the fine print matters. Management elaborated on its free cash flow during the earnings call, noting that the drop in cash flow was related to a combination of seasonal and timely investments into 5G and fiber optics. Capital investments were $6.4 billion and should be scaled back over the year.
Most importantly, management expected this and still affirms its full-year guidance for $16 billion in free cash flow. Based on an annual dividend expense of $8 billion, the company's dividend payout ratio is fine at 50% of the expected 2023 cash flow, assuming AT&T hits this projection. In other words, don't panic about the dividend unless AT&T starts missing its cash flow mark in the future.
There is something concerning
That doesn't mean that AT&T's quarter was sparkling clean. Instead, investors should be more concerned with the company's balance sheet. If you add up the company's long-term debt with its debt maturing within the year, you'll see that it's increased from the prior quarter, from $135.9 billion to $137.5 billion.
Why? It's the same reason-free cash flow wasn't sufficient. If the company took all $8 billion that it should have left over after paying its 2023 dividend, it could bring total debt down to just under $130 billion by year end. But that's if all goes to plan, and it still isn't exactly rapid deleveraging.
T Total Interest Expense (TTM) data by YCharts
AT&T has posted $33 billion in operating cash flow over the past year. However, it's paying $8 billion yearly in dividends, $19 billion in capital expenditures, and $6 billion in interest on its debt. Add it up, and you get $33 billion -- AT&T is essentially breaking even. It's hard to pay down debt principal that way.
Is the stock a buy?
Management expects free cash flow to increase throughout the year, but AT&T still seemingly lacks the financial breathing room to make meaningful progress in paying down its debt. AT&T's debt has been a problem for years, and it could continue weighing on a share price that's down more than 30% over the past decade (without dividends).
So is the stock a buy? It depends; investors can own the stock confidently if the dividend is their only concern. The company's shortfall in cash flow should be a temporary problem. However, investors looking for total returns may want to stay away until management shows clear progress in addressing the company's underlying debt problem.
Some may argue that the stock is cheap at a price-to-earnings ratio (P/E) of just 7.5. However, some stocks are cheap for a reason, and AT&T's debt seemingly has limited the market's sentiment for a company that doesn't have enough cash flow to do much besides pay its dividend.
