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This dividend company could become a giant investor trap. What to watch out for?

Mart Poom
27. 6. 2023
5 min read

The telecom sector has long been popular among dividend investors. Especially because of its high and regular dividend and also because of the relatively stable nature of the business. But one player is in trouble.

AT&T Inc. is an American telecommunications and media company that provides a wide range of services such as mobile and fixed-line services, broadband internet, cable TV, streaming services, next-generation network development and research, and enterprise IT solutions.

The company has roots in a company founded in 1885 called American Telephone & Telegraph, which built and operated the first telephone networks in the United States. Today, AT&T has over 100 million mobile customers and provides landline service to 22 million homes. It also has a strong position in the entertainment and media industry due to its association with media companies such as HBO, Warner Bros. and CNN.



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AT&T not only focuses on providing services to end customers, but a significant portion of its business is focused on enterprise customers, to whom it offers a wide range of IT services including hybrid cloud management, networking, cybersecurity, IoT, and data analytics.

The company has over 250,000 employees worldwide and is one of the largest telecommunications and media companies in the world with a market capitalization of over $112 billion. The company invests billions of dollars annually in research and development of next-generation networks such as 5G and optical networks to continue to provide the broadest portfolio of services to both businesses and end customers.

The big challenge

Despite relatively good profitability and a strong operating and capital spending program, AT&T has lagged the market and its competitors significantly this year. The stock price is down more than 15%, mainly due to weaker-than-expected free cash flow, which raises concerns about the risks in meeting the $16 billion free cash flow target for this year. This is hurting AT&T's ability to pay dividends. Speculation about Amazon's entry into the mobile services market has further depressed the price, although AT&T has denied this.

FCF is below the 16 billion target

As a result, the stock's dividend yield has returned to 7%. While the stock may remain under pressure in the short term due to investor concerns about cash flow and dividends, the underlying operations of AT&T's business remain strong and resilient to a cyclical downturn. AT&T continues to play a key role in providing connectivity and is prudently managing pricing to remain competitive. The jump in quarterly earnings proves this.

With a dividend yield of around 7% and a resilient business model despite the recession, AT&T stock represents an attractive long-term option for yield-oriented investors despite short-term challenges.

AT&T exceeded expectations in the first quarter, confirming its free cash flow guidance of USD 16 billion, despite adverse macroeconomic conditions. Its customer base is also growing faster than its competitors. This suggests that the fundamentals of AT&T's business are strong.

However, the market still undervalues AT&T compared to Verizon $VZ+0.6% or T-Mobile $TMUS+0.4%. Even though they have comparable or better growth and profitability prospects. This suggests that the stock's weaker performance is still influenced by negative investor sentiment, who doubt AT&T's ability to generate enough cash flow to sustain its current dividend.

If AT&T can provide evidence that it will be able to pay dividends again this year, it could positively impact the value of its stock. Particularly when the Fed is expected to slow or stop raising interest rates, which should support AT&T stock growth.Its dividend yield would then fall back to competitive levels.

At the Bank of America conference, AT&T CFO Pascal Desroches talked about growth in 5G, networks and the company's free cash flow. The key takeaway was that postpaid customer additions in the second quarter will be in the 300,000 range, less than the 476,000 expected. While that's not a small number, the market is taking a pretty critical view.

AT&T has had additions of between 424,000 and 928,000 in recent quarters. That growth appears to be slowing - just like that of the competition. The mobility segment, which includes prepaid phones, is the largest part of the business and accounts for 68% of revenues. However, revenue growth has been very moderate recently.

So the current situation is this - It all depends on one thing. $T+1.4% has to demonstrate AT&T's ability to meet its free cash flow target and maintain dividends. Then the stock value will likely rise and the situation could stabilize.

Debt has fallen

AT&T recently sold some of its units and strategic businesses to reduce debt. It sold a 30% stake in its DirecTV unit for $7.1 billion. It spun off WarnerMedia for $40.4 billion in cash. Now AT&T is reportedly looking for a buyer for its cybersecurity unit, which it acquired in 2018 for $600 million.

AT&T has thus managed to reduce net debt by about $24 billion in 2022. It wants to reduce debt to about $100 billion by 2025.

Paying down debt is key to maintaining AT&T's dividend and continued growth in fiber optics and 5G networks. The company has therefore sold some assets, even if it means exiting strategically important sectors. However, this helps to reduce debt and the key thing remains to maintain the dividend and focus on network development.

How do you think things will work out with $T+1.4%? Has the market overreacted?

Disclaimer: This is by no means an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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