Telecom stocks are often reliable income investments to own, but investors aren't so sure that's the case with AT&T (T 1.02%). The stock yields 7.6% right now, as its share price has fallen 19% this year, hitting new lows along the way.
Things have gone from bad to worse this month because there are now concerns that the company has many lead-covered cables it may need to clean up. There's also the potential for litigation to arise from these issues. Does this make AT&T's dividend too risky, or have investors overreacted to these developments?
How safe is the dividend right now?
On a quarterly basis, AT&T pays approximately $2 billion in dividends. For 2023, the company projects that it will generate $16 billion in free cash flow, which is $2 billion more than it produced in the previous year. Assuming it can deliver on that target, that would mean the telecom is paying out roughly half of its free cash flow as dividends, which would be a sustainable amount.
What complicates the issue, however, is that the company has a lot of debt on its books -- more than $130 billion. Investors will want to see some of that debt paid off to lower its overall risk. Simply having enough to pay dividends may not be adequate for income-oriented investors to be willing to take a chance on the telecom stock.
Lead-covered cables could lead to billions in cleanup costs
Another factor potentially threatening the dividend is whether AT&T will need to pay out billions of dollars to clean up lead-covered cables, as some analysts suggest. Investors were so concerned about the possibility of a big liability for the business that they dumped the stock this month, with AT&T's shares hitting 30-year lows.
The Wall Street Journal first reported on the issue on July 9, noting that AT&T and rival Verizon Communications could both have some expensive cleanup costs to deal with the cables. In a response to the story, however, AT&T said it had "previously tested lead-clad cables and continue[s] to believe that they pose no public health risk." The company is nonetheless taking it seriously and doing additional testing.
If the company were to incur billions of dollars in additional expenses, it could certainly derail AT&T's ability to pay dividends. But the company does have a bit of a buffer given its strong free cash flow. And it's also far too early to tell how much this may end up costing the telecom.
Is AT&T's dividend too risky to rely on?
AT&T's dividend yield of 7.6% would be incredibly attractive if it were safe. Even if the company were to reduce its dividend, it would likely remain well above the S&P 500 average of 1.5%.
If you're a risk-averse investor, this is probably not the income stock for you. Even though AT&T's dividend may not be in danger now, the uncertainty ahead could make this a difficult stock to own if you can't stomach the risk. And just because it has recently hit a low doesn't mean a new low can't be right around the corner.
If, however, you're willing to take on some risk, this could prove to be an appealing contrarian investment, because I believe investors may have overreacted.
AT&T's business does face risks, but so do other telecom providers. And even if it incurs cleanup costs, they'll likely be spread out, potentially over years. Plus, at a forward price-to-earnings multiple of only 6, there's a decent margin of safety here for investors even if the company struggles. It may require a lot of patience from investors and some moderate risk tolerance, but AT&T could be an underrated dividend stock worth taking a chance on right now.
