AT&T Inc. (NYSE:T) is currently trading close to its lowest point in a year, despite confirming its free cash flow projections and demonstrating strong performance in its broadband sector during Q2.
The decline in AT&T’s stock price is difficult to comprehend, given that the company has reiterated its $16 billion free cash flow target and has made significant progress in reducing its debt.
Previously, I believed AT&T’s dividend to be secure, although some investors disputed this. However, I am now more convinced than ever that the dividend is safe, and I anticipate significant improvements in AT&T’s balance sheet over the next few years.
Therefore, I believe investors have reasons to be optimistic as AT&T gradually pays off its net debt. In fact, I have increased my own investment in AT&T by 150% when the stock was near its annual low.
AT&T’s Rating History
I have consistently viewed AT&T as an attractive option for passive income investors due to its strong dividend coverage. In my February article, “AT&T Proves The Market Wrong,” I highlighted the company’s compelling value proposition for passive income investors, despite concerns over its dividend. Since then, AT&T’s stock has declined by about 25% primarily due to worries about the company’s free cash flow. While my timing with regards to investing in AT&T was not ideal, I still believe that the fundamental reasons for investing in the company remain unchanged.
Furthermore, I expect AT&T to make significant progress in reducing its net debt in the coming years, which provides another reason to consider buying AT&T shares at their current low level.
AT&T’s Potential to Lower Net Debt
AT&T is committed to reducing its debt burden, which has been a concern for many investors. The company could allocate as much as $4 billion towards reducing its net debt in 2023, with further reductions expected in the following years.
Over the past three years, AT&T has already decreased its net debt by over $20 billion, and I believe it is plausible for the company to aim for annual debt repayment of $4-5 billion going forward.
With an estimated $16 billion in annual free cash flow, AT&T can cover its $8 billion dividend payout, allocate $3-4 billion for capital expenditures, and still have an excess of $4-5 billion to put towards reducing its net debt. As a result, AT&T could potentially reduce its net debt from $132 billion to around $105 billion by 2028, a decrease of over 20%, without compromising its dividend payments.
Moreover, AT&T’s progress in debt repayment would not only improve its balance sheet but also enhance its free cash flow position, leading to better dividend coverage and increased dividend safety.
AT&T’s Undervalued Dividend
AT&T’s low price-to-earnings ratio and increased dividend yield of 7.6% have attracted investors, including myself. Despite the broad decline in investor confidence, I don’t foresee the dividend being reduced in the near future, and AT&T’s low P/E ratio of 6x makes it an appealing investment option.
Both Verizon (VZ) and AT&T offer attractive dividend yields at the moment, but AT&T’s dividend is even more appealing, making it my top choice in the telecommunications sector.
Potential Misconceptions and Conclusion
Passive income investors seem to have overlooked AT&T’s significant revenue and subscriber growth in the Fiber segment, as well as its reaffirmed free cash flow projections for 2023. From my perspective, the dividend is safe and well-supported by free cash flow.
Although AT&T faces a considerable amount of debt, I believe that passive income investors underestimate the company’s ability to systematically reduce its net debt over time without jeopardizing its dividend. With annual net debt reductions of $4-5 billion, AT&T has the potential to significantly improve its balance sheet.
The negative technical setup, characterized by a low P/E ratio and high dividend yield, appeals to contrarian investors like myself. Considering the reaffirmed free cash flow target, selling AT&T shares at their current low valuation would likely be a regrettable mistake.