Artificial intelligence (AI) has become all the rage over the past year. Investors are constantly looking to identify the next company that could emerge as a leader in generative AI, and current market conditions show that they're willing to pay a premium.
While the upside of AI investments could be lucrative, there's still plenty of value in other areas of the capital markets. Investors should keep in mind that the Federal Reserve is working through an arduous battle with inflation. During this hazy macroeconomic period, I would suggest seeking out investments that may be less sensitive to a rising-interest-rate environment.
One such company that has been on my radar is AT&T (T 1.02%). The stock is currently trading near its lowest levels in 30 years. However, an analysis of the financial profile suggests that the company is doing a respectable job generating free cash flow and reducing its net debt. This dynamic has helped AT&T consistently pay a dividend, which currently yields a little over 7%.
From my purview, the stock is artificially deflated, driven by waning investor sentiment. Let's dig into the telecommunications leader and assess whether the stock is worth owning for passive income investors.
Image source: Getty Images.
Cash flow is king
A similar theme among telecommunications businesses is the heavy debt loads carried on their balance sheets. When assessing telecom stocks in particular, investors should keep a keen eye on the company's debt ratio. That's the ratio of a company’s total debt to total assets. If the business isn't generating excess cash flow, it will struggle to pay down debt and strengthen its financial position.
The table below highlights some important financial measures for AT&T over the last year.
| Item | Q3 2022 | Q4 2022 | Q1 2023 | Q2 2023 | Q3 2023 |
|---|---|---|---|---|---|
| Adjusted EBITDA | $10,714 | $10,231 | $10,589 | $11,053 | $11,203 |
| Free cash flow | $3,840 | $6,103 | $1,004 | $4,209 | $5,182 |
| Dividends declared | $0.2775 | $0.2775 | $0.2775 | $0.2775 | $0.2775 |
| Debt ratio | 48.8% | 56.1% | 55.9% | 54.8% | 53.5% |
Source: Company investor presentation. Adjusted EBITDA and free cash flow figures in billions. EBITDA = earnings before interest, taxes, depreciation, and amortization.
There are a few things to unpack here. First, AT&T has not only consistently generated positive cash flow, but has actually steadily increased it. During the third-quarter earnings call, management signaled to investors that the company is raising its full-year free cash flow guidance by roughly $500 million to $16.5 billion.
Given its robust cash flow profile, AT&T has been able to pay down debt. Investors can see that the company's debt ratio has declined throughout the entirety of 2023 -- an impressive feat in a rising-interest-rate environment.
The last thing to point out is that the dividend has remained steady for quite some time. While it would be nice to see the company increase its dividend, I would argue that management is playing a conservative game right now.
Historical dividend trends
The chart below illustrates AT&T's dividend history going back 30 years. It's pretty easy to see that the company had a nice run of steadily increasing the dividend for decades, only to slash it in the past year.
T Dividend data by YCharts
Some may present the idea that over the last several years, AT&T has invested significant capital into 5G development as competition heats up from the likes of Verizon and T-Mobile. While I agree with that thesis, I think there is more to the story.
I would argue that the telecom business has become increasingly commoditized. The major players are in a race to acquire customers and are constantly running promotions in an attempt to undercut one another on pricing. As a result, revenue growth begins to decelerate, which makes it more challenging to run a profitable operation that can reduce debt and pay a generous dividend.
Investors can interpret this chart a number of different ways. I think that by slashing the dividend and keeping it below historical levels, AT&T is prioritizing an optimal net debt ratio above all else. Should the company continue generating strong cash flow and paying down debt, I think there's a path to increasing the dividend in the long term.
Should you invest in AT&T for the dividend?
AT&T stock is likely not going to provide the same type of long-term return as a high-flying growth stock. But as I mentioned above, investors have not seen these trading levels in the stock for decades. Moreover, the company is doing a good job of reducing its debt burden despite high interest rates and is still able to pay a dividend.
Given the deflated price action, I view AT&T stock as an absolute bargain. My strategy for existing investors would be to buy the dip and lower your cost basis. For those considering the stock, I would say that a small position is worth it. Investing in AT&T provides exposure to a blue-chip name that has been a proven dividend payer throughout its history. As cash flow continues to rise and rates eventually fall, I believe that not only is the dividend safe, it has the potential to increase significantly over time.
