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Don’t Let Debt Scare You From the AT&T Dividend Yield

Josh Enomoto

Colloquially known as the dividend king, AT&T (NYSE:T) has more than earned that title thanks to 34 years of annual dividend raises. Even more remarkable than the hard numbers is the context. Through multiple boom-bust cycles, an unprecedented global banking crisis, and several military conflicts, the AT&T dividend yield has stayed true.

But as the old saying goes, past performance is no guarantee of future results. With the telecom giant’s much-covered acquisition of Time Warner, several investors have questioned the viability of the AT&T dividend yield. Primarily, the reason is debt. Well before a federal judge approved the buyout, experts criticized the approximate $175 billion liability the combined entity will carry.

And the situation is not quite over. Recently, the Justice Department filed an appeal against the AT&T-Time Warner verdict. The government claimed that Judge Richard Leon, who presided over the merger case, ignored “basic economics.”

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The DOJ continues to stress that the combined entity has an unfair competitive advantage. In theory, AT&T could withhold valuable Time Warner content on a rival network. If the impact is severe enough, the telecom firm can later pick up dissatisfied customers.

AT&T has vowed to fight the appeal, but the damage has been done. On a year-to-date basis, T stock has dropped more than 15%.

Of course, the awkward dynamic is that many folks are rooting for the government. Without the merger’s debt overhang, the AT&T dividend yield is a much more reasonable undertaking. But with the enormous debt, the math at the very least is extremely challenging.

Also, as our own Will Ashworth pointed out last year, interest rates are rising. Over the trailing-year period, the 10-year U.S. Treasury yield has jumped roughly 27%. That makes debt financing much more expensive.

Why You Shouldn’t Dismiss the AT&T Dividend yield

The nosebleed liabilities that the telecom firm must incur is reason enough for many to avoid the AT&T dividend yield. I completely understand the reasoning. The company faces an uncertain future and a lagging broader market. In these circumstances, it’s better to have a clean balance sheet.

But that’s not to say that the lofty AT&T dividend yield is a pipe dream. For one thing, the company features consistently colossal free cash flow. Currently, its trailing 12-month FCF is $18.3 billion, up nearly 81% from the end of 2014.

Furthermore, management has stated its intention to not only maintain but to improve the AT&T dividend yield. While the deal will balloon the telecom’s debt levels, it will also enhance the asset base. Synergies between the two giants should significantly boost revenues and earnings.

The counterargument is that the debt explosion is a guaranteed result of a completed merger. Increased earnings, on the other hand, is a variable concept. It could happen, and some might argue it’s a probability. However, all probabilities have associated uncertainty risks. The market deals with reality; hence, the drop in T stock.

Adding to doubts is that cord-cutting has accelerated in recent years, as InvestorPlace contributor Bret Kenwell notes. AT&T’s other big deal, DirecTV, hasn’t panned out so well.

But despite these serious pressures, I’m giving the edge to the AT&T dividend yield being sustainable. That’s because we have to consider the grandest context of them all: AT&T is one of the few elite companies that can make the 5G-network rollout work.

5G isn’t just about faster internet speeds. To actualize the benefits requires extensive networks and resources, which AT&T has in abundance. Plus, with Time Warner’s assets, it can better compete with would-be disruptors like Facebook (NASDAQ:FB) or Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).

Look for T Stock to Make a Bounce Back

So is the 6% AT&T dividend yield worth it? I believe it is. Admittedly, the gargantuan debt load is a serious concern, as is the rising benchmark interest rates. However, I trust that management isn’t dumb. It knows the motivations behind most T shareholders, and it isn’t to get rich quick.

Assuming that the yield is reasonably safe, prospective T stock buyers may also look forward to capital gains. In prior sessions, AT&T shares have tested the $31 support level, only to bounce back up. I doubt that the bears will be successful at this juncture. Moreover, the options market implies significant upside over the next several months.

In summary, T stock is backed by a stalwart that has the keys to a paradigm-altering technology. Also, the company has a rich history of dividend payouts to which management is strongly committed. Combined, buyers have the chance to gain both passively and actively. You’re not going to find too many deals like this, especially in this market phase.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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