For months, income investors justified the investment in AT&T (NYSE:T) as low risk. AT&T stock paid a dividend of about 7% at $30. But in the last two months, selling pressure intensified and it shows no signs of reversing course.
Why is bearish selling picking up the pace for AT&T on the stock market? What will it take for shares to rebound? And how does this affect the stock’s dividend?
AT&T Stock in a Downtrend
AT&T started to rebound earlier in the summer, when the novel coronavirus appeared to be somewhat under control. Soon enough, though, the U.S. lost its ability to contain the spread after Memorial Day on May 31. As infections grew, businesses had to implement strict social distancing rules again. More importantly for AT&T stock, movie theaters could not reopen.
For one, WarnerMedia’s Tenet would have likely made more than its $300 million in global ticket sales if the pandemic had stayed quelled domestically. The limited theater opening and a reluctance for moviegoers to watch it hurt AT&T’s revenue. Variety wrote:
“‘Tenet’ has struggled to attract stateside audiences with the kind of fervor that typically greets Nolan films such as ‘Inception’ and ‘Dunkirk.’ Audiences seem hesitant to return to cinemas when coronavirus infection rates remain stubbornly high in the U.S., but the weak results are also attributable to the fact that major markets such as Los Angeles and New York haven’t allowed theaters to reopen due to the pandemic.”
Still, I’m not sure that the studio can blame the pandemic entirely for the film’s weak performance.
Regardless, when it does report quarterly results, the telecom giant will probably post negative cash flow. This threatens its dividend. Yet CEO John Stankey has said in past conference calls that he is willing to increase the payout ratio from 50% to 60% to sustain or raise the dividend.
Dividend at Risk
At its current yield in the 7% range, AT&T is a better income stock than Verizon (NYSE:VZ), whose yield is in the 4% range. But Verizon stock has held up, and is actually in an uptrend. Conversely, AT&T stock faces strong resistance in the $25 – $29 range. And it may reach new lows if the WarnerMedia division continues to hurt the bottom line.
Because of this, AT&T will probably cut tens of thousands of jobs at the studio. This will let online streaming giants like Netflix (NASDAQ:NFLX) and Roku (NASDAQ:ROKU) hire them. Further, HBO Max still needs more attention and advertising support to grow. With the streaming service costing more per month, AT&T may have a tougher time building its subscriptions.
Of course, all of these uncertainties put some question marks around the dividend.
Tipranks reports that 8 out of 15 analysts rate AT&T stock as a buy, with an average price target of $31.82. But given the ongoing pressure at WarnerMedia — and increasing online streaming pressures against AT&T’s cable TV packages — investors should not assume the stock will rise from here.
In a downside scenario, investors may build a five-year discounted cash flow EBITDA exit model. Assume the following:
|Discount Rate||7.5% – 6.5%||7.00%|
|Terminal EBITDA Multiple||6.6x – 8.6x||7.6x|
|Fair Value||$18.49 – $30.83||$24.55|
At a 7.6 times terminal EBITDA multiple, the stock is worth less than $25. Still, this would imply an 8.3% dividend yield. Assuming that AT&T does not cut its dividend, income investors would buy the stock aggressively at that level.
Income investors who intend to hold shares for many years should buy AT&T stock at current levels. Despite AT&T’s downtrend, the dividend is sustainable, and the studio business will eventually rebound. But it’s also important to remember that the pandemic is an ongoing risk, entering its second phase. The winter months could bring more turmoil to the movie sector and for businesses.
This will have a mixed impact on the telecom giant. Although the theaters will be hurt, more customers may sign up for the company’s cable television services and HBO Max. They may also upgrade their smartphones and pay a higher monthly subscription rate.
All of these trends will lead to higher cash flow generation. It will also allow AT&T to raise its dividend as promised, pay off more of its debt, and buy back its shares at a low price.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.
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