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AT&T Expects to Keep Dividend Safe But Frozen in 2021 to Prioritize Investments and Debt Reduction

AT&T on Friday kept its dividend frozen at 52 cents per share for the first quarter of 2021, unchanged from the prior four quarters. 

This marked the first time in company history that the telecom, media, and entertainment giant has held its dividend flat for more than a year.

To retain its status as a dividend aristocrat, AT&T has until the fourth quarter of 2021 to increase its dividend. 

That would keep AT&T’s total dividends per calendar year on the rise, which is how S&P calculates dividend growth streaks when maintaining its dividend aristocrats index. 

Semantics aside, a dividend freeze often signals that a business faces stress and desires to be more conservative with its cash flow. 

In AT&T’s case, we’ve discussed how the pandemic has hurt the company's Warner Bros. TV and film studio business (7% of sales) with production pausing and movie theaters temporarily closing.

The firm's pay-TV business (17% of sales), which includes HBO, also continues losing DirecTV subscribers to more affordable streaming services while AT&T scrambles to scale its own offerings.

These headwinds have driven AT&T's mid-single digit decline in sales and earnings over the past year and slowed the company's deleveraging progress following its transformative acquisitions of DirecTV and Time Warner.

Fortunately, AT&T's overall cash flow has remained resilient with its wireless business (around 40% of sales), high-speed internet division (5%), and business network services (9%) seeing revenue growth last quarter.

Management expects to generate at least $26 billion of free cash flow in 2020, down less than 10% compared to pre-pandemic guidance calling for $28 billion.

At an investor conference on December 8, AT&T's CEO John Stankey said he expects the company in 2021 to generate around $26 billion of free cash flow again despite slightly higher capital spending compared to 2020.

That's plenty to cover AT&T's $15 billion dividend. A token penny increase to the quarterly dividend would have raised AT&T's annual dividend cost by about $285 million.

While that may not seem like much compared to AT&T's projected $11 billion of free cash flow after paying its current dividend, management wants to preserve as much capital as possible for essential investments and debt reduction.

For example, analysts believe AT&T may spend between $4 billion and $20 billion at a December auction for spectrum to keep its wireless network competitive with Verizon and T-Mobile in the 5G era.

Meanwhile, AT&T may need to pour even more money into its HBO Max streaming service, which was on track to receive $2 billion of investment in 2020.

For comparison, Disney at its investor day on Thursday revealed plans to invest $8 billion to $9 billion in its core streaming service Disney+, at least double what was initially anticipated as the race for original content speeds up in the streaming wars.

Given this upward pressure on spending to remain competitive, plus AT&T's desire to reduce its $149 billion net debt load by as much as $20 billion to hit its leverage target, the company's cash flow after paying dividends may not stretch as far as it seems.

Fortunately, AT&T's liquidity remains strong with $10 billion of cash on hand and less than $8 billion of debt maturing each year through 2025.

Low interest rates have enabled AT&T to access debt markets on favorable terms as well, reducing some pressure to deleverage faster. And management continues divesting "non-core" assets from the firm's $500 billion balance sheet to free up more cash.

For example, AT&T on Wednesday announced plans to sell its anime streaming service business Crunchyroll for $1.2 billion.

Management continues shopping DirecTV too, with the Wall Street Journal reporting that a deal could be reached by early 2021. 

AT&T paid $67 billion (including debt) for DirecTV in 2015, but offers today are reportedly near $15 billion following years of subscriber losses for linear TV. 

We estimate DirecTV accounts for less than 5% of AT&T's EBTIDA. If AT&T sold this business, we believe the company's free cash flow payout ratio would rise from about 58% this year to around 65% to 70%. 

That's about in line with AT&T's historical average, so a full divestiture wouldn't necessarily pressure the dividend.

The bottom line is that AT&T is making moves to ensure it has enough money to invest in its strategic priorities (wireless network, broadband, and streaming) without stretching its balance sheet further. 

Keeping the dividend frozen, at least for the next few quarters, is now part of that plan. In its press release announcing the dividend for next quarter, AT&T provided assurance that it plans to "sustain the dividend at current levels" for 2021:
"The company expects to have the financial flexibility in 2021 to continue to invest in growth areas, sustain the dividend at current levels and focus on debt reduction."

Management's dividend guidance already takes into account pandemic-related headwinds, spectrum spending, streaming investments, and potential divestitures. 

So while a dividend freeze is disappointing, income investors can find some relief in knowing that the payout remains an important and realistic priority despite the challenges AT&T is working through. 

Looking further ahead, AT&T appointed a new CEO in July and will have a new chairman for its board beginning in January. Management wants to restore credibility with investors following AT&T's ill-timed and costly expansions into pay-TV and media. 

Shedding non-core assets to refocus AT&T on its core wireless, broadband, and streaming businesses will remain a priority, as will debt reduction. Keeping the current dividend in place would help rebuild trust with investors, too. 

Based on what we know today, we expect AT&T's dividend to remain safe. We would only consider downgrading the company's Dividend Safety Score if AT&T's cash flow outlook deteriorated and further slowed deleveraging progress. 

This could happen if AT&T's wireless business starts to show cracks as 5G takes hold, HBO Max struggles to grow and requires more investment, or some other material headwind arises. 

We will continue keeping a close eye on AT&T's progress returning the business to profitable growth and paying down debt, with the company's next earnings report due out on January 27. As always, we will provide updates as necessary.

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