Investors who watch AT&T (T 1.88%) closely know that it has spent the last two years atoning for a costly mistake. It not only strayed from its core service offerings but also overpaid to enter the pay-TV and content markets.
But although it has spun off DirecTV and the former WarnerMedia to Warner Bros. Discovery, investors continue to hang up on the stock, and its dividend is a likely reason. Despite the 47% cut, the payout has brought consternation instead of relief -- so much so that AT&T might want to eliminate the dividend completely.
AT&T's dividend reduction cut both ways
The focus on the dividend might come as a surprise, since after 35 years of consecutive increases, AT&T slashed the annual dividend from $2.08 per share to $1.11 per share. Since the current payout offers a dividend yield of 6.8%, AT&T might appear to have merely adjusted the dividend to an appropriate figure.
However, income investors should always remember that AT&T can adjust its payout at any time for any reason. In past years, it had hiked the payout annually, and that streak of increases arguably reinforced the sentiment that the dividend would remain stable and grow over time.
Unfortunately, investors have little reason to remain confident at current payout levels. Even after the adjustment, AT&T's dividend yield is more than quadruple the S&P 500 average cash return of 1.6%. That return in itself could inspire AT&T to cut the payout again.
Dividend sustainability
Moreover, the dividend is facing more issues than just confidence. In the first quarter of 2023, free cash flow, which often finances dividends, came in at $1.0 billion. That did not cover the quarterly dividend cost of $2.0 billion. Although the company could fund the payout if it meets its estimate of $16.0 billion free cash flow for the year, the low Q1 free cash flow figure is cause for concern.
Furthermore, even after the cash infusion from the spinoff of WarnerMedia, AT&T holds $137.5 billion in total debt. That exceeds the stockholders' equity on the balance sheet, which now stands at $108 billion. Eliminating the dividend would save AT&T $8 billion annually, freeing the company to make progress on reducing its considerable debts.
Additionally, dividends are not the only factor pressuring its free cash flow. Maintaining and expanding 5G and fiber networks comes at a considerable expense. The company spent $4.3 billion in Q1 on capital expenditures, which is consistent with spending in past quarters.
With ongoing competition from Verizon and T-Mobile, it likely cannot afford to cut that spending. But AT&T would face no such concern with a possible dividend cut. T-Mobile does not pay a dividend and has delivered the highest returns of the nationwide 5G service providers. Additionally, since Verizon's dividend struggles resemble AT&T's, Verizon's challenges might validate AT&T's case for eliminating the dividend.
Do not buy AT&T as long as it pays a dividend
Ultimately, AT&T's best move is probably to eliminate its dividend.
Although a dividend tends to serve as a stabilizing force in a stock, the cost of AT&T's dividend and the company's massive debts appear to have made its payout the elephant in the room. By eliminating $8 billion per year in dividend costs, AT&T could better address the debt obligations that are, arguably, a more significant concern.
Ending payouts would also help AT&T follow in the footsteps of T-Mobile, a telecom stock that has delivered considerable returns for investors without paying dividends.
Hence, after years of stock-price declines, it seems that suspending the dividend could foster more investor confidence than maintaining it.
