Shares of AT&T (NYSE: T) have fallen more than 25% from their 52-week high. Weighing on the telecom giant’s stock is concerns about its free cash flow. That has caused some worries that it might not be able to maintain its lofty dividend, which now yields more than 7% following its share price decline.
However, dividend investors can breathe a bit easier after AT&T’s CFO recently said the company is on track to achieve its free cash flow guidance for the year. That suggests the dividend won’t see another reduction in the near term. Nevertheless, that doesn’t mean income-focused investors should rush out and buy its stock.
AT&T’s CFO Pascal Desroches recently affirmed the company would produce between $4.5 billion and $5 billion of free cash flow during the third quarter. That gave the CFO the confidence to reiterate the company’s guidance that it would generate at least $16 billion in free cash this year.
It would give the telecom giant the cash to fund its dividend and get back on track with de-leveraging its balance sheet:
As that slide shows, net debt hasn’t budged over the past year despite generating over $15.2 billion in free cash flow. However, that should change in the coming months. AT&T expects to produce $11 billion in cash in the second half of 2023, leaving it with over $4 billion after paying dividends and other costs. That would help push its leverage ratio down toward 3.0 by year’s end. Meanwhile, it expects leverage to improve to 2.5 by 2025 as it continues producing excess free cash to repay debt.
While that’s an improvement, AT&T has a higher leverage ratio than Verizon (NYSE: VZ). Its rival’s leverage ratio was already down to 2.6 at the end of the second quarter (an improvement from 2.7 in the year-ago period). Verizon’s long-term target is to get leverage between 1.75 and 2.0. However, it aims to resume share repurchases once it’s below 2.25, which would slow its de-leveraging. Verizon’s lower and improving leverage ratio recently gave it the confidence to increase its dividend by another 1.9%, its 17th straight year of dividend growth.
AT&T’s elevated leverage ratio is one of the factors that led it to cut its dividend by almost half last year following the spin-off and merger of its media business to create Warner Bros. Discovery. That reduction enabled AT&T to retain more cash to reinvest in its business and for debt reduction.
There had been some concern that it might need to cut its payout again to accelerate its de-leveraging. That seems less likely with the second-half improvement in free cash flow coming in as expected. AT&T’s high-yielding dividend thus looks safe and should grow safer in the coming quarters as leverage goes down.
However, the company likely won’t be in the position to join rival Verizon and increase its dividend anytime soon. It probably wouldn’t even consider a dividend increase until after it hits its 2.5 target in 2025.
AT&T’s main draw these days is its high-yielding dividend. While there was some concern about its sustainability, those fears should fade as the company’s free cash flow and leverage ratio improve. AT&T accordingly looks likely to maintain its dividend in the coming quarters. That might make it look like a potentially enticing option for those seeking a higher-yielding fixed income stream than most bonds.
However, its payout isn’t as attractive as Verizon’s. Its rival offers an even higher-yielding dividend (currently 7.8% versus 7.4% for AT&T) that should continue rising at a modest rate in the coming years. That dividend also looks safer, given Verizon’s lower leverage ratio and improving free cash flow profile. Verizon overall looks like the better choice for income-seeking investors these days.
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