NEW YORK (TheStreet) -- AT&T (T) 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.
3. Installment plans instead of subsidies
AT&T is moving toward installment plans for its customers, offering them cheaper monthly prices than on contract. The main problem with this is that the company obviously has to pay upfront to actually purchase the phone before it can be given to the customer. And the longer the customer keeps the phone, the less profitable it is for AT&T.
The outflow and inflow of cash in this case is not balanced, so AT&T may further face cash flow problems -- affecting dividends directly.
So, what can we conclude?
There is no doubt about the fact that AT&T is an extremely strong company that has managed to grow significantly. It may also be a very profitable option for investors at present.
However, in the long run, the company may not be able to maintain the dividend that it has been paying, owing primarily to its cash flow problems. If these issues are not resolved by the company's management soon enough, AT&T will find itself in a situation where it may not be able to pay attractive dividends anymore. And then investors will rush for the exits.
At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates AT&T INC as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:
"We rate AT&T INC (T) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, attractive valuation levels, largely solid financial position with reasonable debt levels by most measures, notable return on equity and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- Despite its growing revenue, the company underperformed as compared with the industry average of 2.6%. Since the same quarter one year prior, revenues slightly increased by 1.6%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
- The debt-to-equity ratio is somewhat low, currently at 0.91, and is less than that of the industry average, implying that there has been a relatively successful effort in the management of debt levels. Despite the fact that T's debt-to-equity ratio is low, the quick ratio, which is currently 0.56, displays a potential problem in covering short-term cash needs.
- The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. Compared to other companies in the Diversified Telecommunication Services industry and the overall market on the basis of return on equity, AT&T INC has underperformed in comparison with the industry average, but has exceeded that of the S&P 500.
- The gross profit margin for AT&T INC is rather high; currently it is at 56.37%. Regardless of T's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, the net profit margin of 10.88% trails the industry average.
- You can view the full analysis from the report here: T Ratings Report