To The Moon

$AT&T Inc(T)$

Is AT&T Still a Good Dividend Stock?

After slashing its dividend and free-cash-flow guidance this year, AT&T requires reevaluation as an income stock.

AT&T (T 0.98%) has long been valued by investors interested in dividend-paying stocks. The company until recently was a Dividend Aristocrat, delivering annual payout hikes like clockwork for 36 consecutive years.

Its impressive streak of hikes stopped after the pandemic struck in 2020, squeezing AT&T's sales as the company closed stores amid widespread lockdowns. Then this year, AT&T slashed its annual dividend payout nearly in half from $2.08 per share to $1.11. That's not all. In July, AT&T revised its full-year 2022 free-cash-flow (FCF) estimates downward from $16 billion to $14 billion. Declining FCF can affect a company's ability to fund its dividend.

Given this streak of dividend-related bad news, AT&T is arguably no longer a good income investment. Or is it? The company's dividend still sports a high yield, currently about 6%. Before deciding to buy shares or cross AT&T off your investment list, it's worth examining the company in more detail.

The new AT&T

Today's AT&T is different from its pre-pandemic days. Under CEO John Stankey, who took over in 2020, it underwent substantial changes, divesting the entertainment assets it spent billions to acquire under previous leadership.

Those changes concluded in April when AT&T's WarnerMedia merged with cable company Discovery to form Warner Bros. Discovery, returning AT&T to a telecom-focused organization. The gambit is paying off.

This new incarnation is successfully capturing customers, particularly among post-paid phone subscribers, the telecom industry's most valuable customer segment. The company saw its post-paid phone net additions reach 813,000 in the second quarter, its highest second-quarter total in over a decade.

AT&T's 2022 post-paid phone net adds of 1.5 million through two quarters outpaced last year's 1.4 million. If this performance continues through the second half of the year, it can exceed last year's record-setting 3.2 million post-paid phone net adds, a total higher than the previous 10 years combined.

These customer gains propelled AT&T's second-quarter mobile revenue to $19.9 billion, a 5.2% increase over the prior year. The company's 2022 revenue is outpacing previous years, after adjusting for AT&T's divested assets, thanks to growth in its mobile and fiber-optic broadband businesses.

AT&T's new fiber-optic internet product experienced nearly 28% year-over-year revenue growth in the second quarter, helping its broadband consumer business to hit $2.4 billion, up 5.6% from the prior year.

AT&T's challenges

Given its success, why did AT&T cut its dividend as well as FCF guidance this year? The former makes sense in light of the divestiture of WarnerMedia, which contributed over 20% of AT&T's revenue last year, so its loss necessitated a dividend cut.

The reason for the FCF reduction is more complicated. For starters, inflation-related costs rose $1 billion above expectations.

Inflation is also starting to affect the bill-paying ability of customers. The company saw a sudden rise in customer payment delays in the second quarter.

AT&T also has plenty of expenditures. It's investing $24 billion this year and next on 5G and fiber-optic network expansion. And it is paying down the massive debt accumulated during its entertainment media buying spree to reach a net debt-to-adjusted-EBITDA ratio in the 2.5 range by next year. At the end of the second quarter, the ratio was 3.23.

This combination of factors forced AT&T to cut FCF estimates. The company enacted price hikes to offset rising costs, but higher prices could fuel customer defection. Competition in the telecom sector is heating up. New competitors have entered the fray, such as Charter Communications. So it's no surprise AT&T saw post-paid phone churn increase from 0.69% last year to 0.75% in the second quarter.

AT&T as an income investment

The new AT&T's performance was a bit of a mixed bag in the second quarter. Yet despite news of lower FCF, the dividend is secure.

That's because the company expects 2022 adjusted earnings per share, when allowing for divested businesses, to be at least $2.42, and its dividend payment is about half that. So the dividend payout ratio leaves plenty of cushion. That said, don't expect a dividend increase anytime soon given the FCF situation and anticipated capital expenditures.

Ultimately, it's ideal to hold off buying shares until third-quarter earnings are released. Investors can then better evaluate the new AT&T, seeing if it can sustain its success while mitigating challenges through the current inflationary environment. In the meantime, there are better dividend stocks to consider.