Despite strong gains for the broader market this year, AT&T (T 2.72%) stock continues to struggle. The company's share price is down nearly 19% so far in 2023. With the stock trading at low earnings multiples and offering a big yield, shares may be looking attractive for income-seeking investors on the hunt for deep value plays. But even investors who are hungry for great dividend plays should consider metrics beyond price-to-earnings ratios and dividend yield before going all in on this telecom giant.
The chart below uses data provided by New Constructs and tracks the progression of AT&T's return on invested capital (ROIC) against its weighted average cost of capital (WACC). Check out the progression and read on for a closer look at what these two metrics might mean for this beaten-down, high-yield dividend stock.
Image source: The Motley Fool.
AT&T's ROIC is falling behind
Return on invested capital is calculated by dividing net profit after taxes by average invested capital. Meanwhile, WACC is a reflection of the use of equity and debt in relation to a company's market capitalization and corporate tax rate.
Because WACC factors in costs associated with using debt or stock to fund operations, some investors use it as a benchmark for the minimum ROIC that a worthwhile investment needs to have. When WACC is higher than ROIC, it's typically a sign that value is being destroyed and that shareholders should be cautious.
As shown in the chart above, AT&T's ROIC fell below its WACC in 2022. ROIC remained below WACC for the trailing-12-month period ending at this year's second quarter, with the gap actually widening.
AT&T's outstanding share count has barely grown at all over the last few years. Its share count is actually down roughly 2% over the last five years due to some stock buybacks in 2020. The company doesn't rely on stock to pay employees or fund other aspects of its operations. But it does have a big debt problem, and that problem is reflected by its rising WACC.
Heavy debt continues to dog this telecom giant
Due to costly acquisitions and ongoing investments in wireless and fiber-internet infrastructure, AT&T has leaned heavily on credit over the last decade. To put things in perspective, the company closed out the second quarter with $143 billion in long-term debt. With interest rates rising over the last couple years, its already sizable interest expenses have risen as well.
In the second quarter alone, AT&T had interest expenses of roughly $1.6 billion -- and this wasn't an anomaly for the company. It also had roughly $1.7 billion of interest expenses in this year's first quarter, and it's on track to exceed the $6 billion in interest expenses that it had in 2022.
The telecom giant has managed to pay down roughly $20 billion in debt over the last three years, but the company's financial foundations aren't as rosy as a quick look at its free-cash-flow generation would suggest. The acquisitions and subsequent spinoffs of Time Warner (now Warner Bros. Discovery) and DirecTV destroyed shareholder value and continue to have long-tail effects in the form of high interest expenses on debt.
Is AT&T stock still a buy for its fantastic dividend?
AT&T expects to generate $16 billion in free cash flow this year, which is enough to cover its dividend and take another small bite out of its debt load. The company is trading at just 6 times this year's expected earnings and pays a dividend yielding 7.4%.
While the stock looks quite cheaply valued, the company's ROIC trend and heavy debt load suggest that shares come with a degree of risk that is significantly higher than its P/E ratio might imply.
AT&T's beaten-down valuation, big yield, and strong free cash flow generation open the door for the company's share price to see a substantial rebound above current levels, but heavy interest expenses and industry competition mean the stock is hardly a sure thing.
