The biggest disappointment from AT&T's (T 3.86%) first-quarter earnings report was its dismal free cash flow.
Free cash flow is extremely important for AT&T investors, many of whom look for the stock to continually throw off cash in the form of its high-yielding dividend. But after the wireless carrier generated just $1 billion in free cash flow in the first quarter, the health of its dividend may be called into question.
AT&T is dipping into its cash reserves
AT&T's first-quarter free cash flow was so small, it had to dip into its cash reserves to meet its dividend payment. AT&T paid out $2.1 billion in dividends last quarter. As a result, it ended the first quarter with about $900 million less in cash and equivalents than it started it with. It also added about $1.6 billion in debt on top of the $135.9 billion it ended 2022 with.
Management reiterated its expectations to produce $16 billion in free cash flow for 2023. The first quarter represents a "low watermark" due to increased device expenditures (from fourth-quarter promotions), incentive bonus payouts, and the timing of capital investments.
Of course, those first two factors also affected the company's results in the first quarter of 2022, when it generated $2.8 billion. That amount also notably fell short of its dividend obligation, and AT&T proceeded to cut the dividend with the spinoff of WarnerMedia.
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AT&T is trying to maintain a careful balancing act
AT&T's management knows the importance of the dividend to its investors, so it's going to do everything it can to keep it intact and provide confidence to investors.
That starts with the reiteration of its $16 billion outlook for free cash flow in 2023. Management says device payments, incentive bonuses, and elevated CapEx all combined to hurt first-quarter free cash flow by $3 billion to $4 billion. And while free cash flow is historically loaded in the back half of AT&T's year, there's a lot of ground to make up. Expecting $5 billion per quarter in free cash flow from AT&T is asking a lot. It did that once last year (fourth quarter) and produced less than $4 billion in free cash flow every other quarter.
Meanwhile, management is committed to paying down its debt, which actually climbed in the first quarter. With $13.8 billion in current debt obligations and a higher interest rate environment, kicking the can down the road by issuing new debt is becoming very expensive.
On top of paying down debt and maintaining its $2 billion-per-quarter dividend, AT&T still needs to invest in its network build-out. The competition is ahead of it in 5G coverage and deployment of services like fixed-wireless access, which AT&T has been slow to come around to. While it's managed to keep customers through aggressive device promotions, a lagging network will eventually push customers to search for greener pastures.
AT&T needs to balance all of those cash commitments while potentially producing less cash than it provided in the outlook it already revised downward last summer.
Is the dividend safe?
It would be a surprise if AT&T slashed its dividend this year after it just cut its payout last year.
Still, investors should be wary of all the cash commitments AT&T faces and understand the company's need to show improvement in free cash flow. After telling investors it would generate $20 billion in free cash flow in 2023, it was forced to face reality and say it would only generate $16 billion. And after the dismal first quarter, investors should have less confidence in that outlook.
Management may find a way to pay the dividend, but it could come at the cost of either debt paydown or making the necessary capital investments in its network. Meanwhile, there are likely better ways for investors to get a dividend on par with AT&T's or invest in a wireless carrier with greater potential for stock appreciation.
