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3 Reasons to Worry About AT&T's Dividends

NEW YORK (TheStreet) -- AT&T (T - Get Report) is one of the leading names in the telecommunications industry -- it's often seen as a stock that investors don't have to worry about after they buy it. But that might be changing soon.

Analysts are skeptical about whether AT&T's dividends will be able to please shareholders in the future owing to an assortment of reasons. Here are the big ones.

1. Payout ratio

The payout ratio is basically the portion of the earnings of a company that is paid out as dividends. The free cash flow dividend payout ratio determines the portion of the free cash flow that is paid out. The ratios are important in determining if a company is actually paying dividends because of positive revenue generation -- or if those dividends are being paid out in order to make the investors believe that the company is doing great even if it isn't.

Above 100%, these ratios are not sustainable. At that point the company is using its reserves to pay dividends. In other words, it cannot actually afford to pay the dividends that it has declared. In the past 13 years, AT&T reached its all-time high payout ratio of 249%. This ratio has decreased, but it was still significantly high at 66% by the end of the first quarter of 2014.

The company reported earnings after the market closed on July 23. On the surface, the results were terrible. The company reported earnings 62 cents per share (missing estimates by a penny) on revenue of $32.57 billion (missing estimates by $840 million). The stock dropped 1.06% the day it reported. And since then, the stock has declined 2.14%, to $34.26 as of noon on Friday.

Compared to the previous year, total revenue has increased by 2% for the Q2. The only notable thing about this portion of the earnings report is that the wireless sector increased revenues by 4%, which accounts for almost 55% of the AT&T's revenues. The 27% decline in other revenue is insignificant as it only accounts for 0.02% of revenues.

AT&T's core free cash flow was at an ever higher value of 92% in the previous quarter.

The sustainability of dividends in this scenario seems difficult for the company. Of course, some analysts may argue that these ratios can continue decreasing in the future.

2. Transitions may not always be as easy as they seem

Whenever a company is going through massive changes that may create turmoil in its operations, the company's management uses the term "transition" to justify the mess to the investors and to ensure that they don't lose faith in the company's management.

The thing about these periods of transition is that they can stretch out over a long period of time. If a company is not doing well, the management can simply say that the company is "transitioning" into a better company. AT&T is trying to transition into a prepaid provider through its Cricket brand. Its management has revealed that there will be increased capital expenditure to allow for this.

So the company will either be compromising on its liquidity further, or interest costs will increase for the company owing to the debt it will require. Either way, this is not good news for the investors, as these may adversely impact dividends.

The final problem is yet again related to the company's cash flow.

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