AT&T (NYSE: T) has one of the highest dividend yields in the S&P 500. At nearly 6%, it's a lot higher than the market index's average of 1.3%. Sustainability concerns are a big driver of that high yield. The telecom and broadband company slashed its payout by nearly half in early 2022 following the spinoff of its media business into Warner Bros. Discovery. It needed to retain additional cash to invest in its business and repay debt.
The company has struggled to cut its debt in recent years, which caused concerns that it might need to cut its payout again. However, its leverage ratio is starting to come down (with more progress expected). Meanwhile, its investments are beginning to pay dividends. Because of that, it's starting to look like AT&T's dividend might finally be safe from the risk of another reduction.
Finally turning the corner
AT&T recently reported strong second-quarter results. While its overall revenue was down slightly (falling from $29.9 billion in the year-ago period to $28.9 billion), that was entirely due to a $0.3 billion decline in equipment revenues. The company's mobility services revenue rose 3.4% to $16.3 billion, while its consumer broadband revenues surged 7% to $2.7 billion.
The company also delivered strong free cash flow. While operating cash flow fell from $9.9 billion in last year's second quarter to $9.1 billion this year, its free cash flow surged nearly 10% to $4.6 billion. AT&T benefited from $0.7 billion in free cash flow from its investment in DirecTV and a $1 billion decline in capital investment (which fell to $4.9 billion).
That strong free cash flow enabled AT&T to pay its dividend while also repaying $1.9 billion of debt over the past quarter. It has now reduced its net debt by $5.1 billion over the past year. That debt reduction has lowered its leverage ratio from 3.1 times to less than 2.9 times. While leverage is higher than it would like (and above rival Verizon's 2.5x level), it's heading in the right direction.
More improvement expected
AT&T expects its financial results to continue improving. The company is growing its broadband business at a healthy clip. That's driving growth in its mobility business. Nearly 40% of its fiber customers are now also mobility subscribers. That's up from 35% in early 2021 as it converts more fiber customers to mobile subscribers.
The company also expects to achieve incremental cost savings, targeting more than $2 billion by the middle of 2026. On top of that, it anticipates achieving additional efficiency gains from its growing scale and new technologies like artificial intelligence.
Rising revenue and falling costs should boost AT&T's cash flow. It plans to continue using a portion of that to invest in long-term growth by expanding its 5G and fiber capabilities. It also plans to strengthen its balance sheet further by repaying additional debt. AT&T's target is to get leverage down to the 2.5x range in the first half of next year. That will further enhance the long-term sustainability of its high-yielding dividend.
Once AT&T reaches its leverage target, it could return even more cash to shareholders by increasing its dividend and launching a share repurchase program. The company could also continue repaying debt to put itself on an even stronger financial foundation. For example, Verizon's long-term leverage target is 1.75x to 2.0x by the end of 2026. AT&T could seek to get down to a similar level.
Heading toward a more sustainable future
AT&T's strategy is starting to pay dividends. Its consumer broadband and mobile revenues are rising while its free cash flow is improving. That's enabling the company to repay debt, putting it on track to hit its leverage target by the first half of next year. These improvements suggest that AT&T's dividend finally looks safe from the potential of another cut. Because of that, it's a much more attractive option for those seeking a high-yielding income stream.
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Matt DiLallo has positions in Verizon Communications. The Motley Fool has positions in and recommends Warner Bros. Discovery. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
Is AT&T's Nearly 6%-Yielding Dividend Finally Safe? was originally published by The Motley Fool