Can retirees still trust AT&T’s 5.8% dividend yield? | The motley fool

US wireless carrier AT&T (T -0.97%) is a polarizing stock among investors. The stock has fallen nearly 30% in price over the past decade, which is a tough pill to swallow. However, including the dividend and AT&T’s famously high-yielding stock generated a positive return of 50%.

Indeed, dividends can have a powerful impact on investment returns.

More than returns, retirees depend on dividends for the passive income they provide, which can help pay for living expenses. For those investors, what matters most is a high dividend yield that they can trust will keep coming quarter after quarter.

So can you trust AT&T’s 5.8% yield?

AT&T cut its dividend in 2022

A company that recently cut its dividend may not inspire confidence, but that’s exactly what AT&T did in early 2022. The telecom company spent most of the last decade in massive mergers to acquire DirecTV (49 billion) and Time Warner ($85 billion) to expand into media. This was ultimately a failure, prompting AT&T to sell DirecTV and spin off its Time Warner assets by 2022, leaving the company with over $200 billion in long-term debt.

Dividend investors hate to see dividend cuts, but the dividend cut was undoubtedly necessary. The dividend cut freed up cash flow to help pay down debt. With an infusion of cash from spinning off Time Warner, AT&T reduced its long-term debt to $132 billion. There is more work ahead, but this is a massive relief, especially in a higher rate environment where any restructured debt will bring higher interest costs.

The balance sheet is in much better shape now, allowing investors to focus on AT&T’s cash flow to help determine the safety of its dividend. A healthier balance sheet means less risk of another downgrade if the business takes a sudden downturn. In other words, the cut has made the dividend safer today.

Can AT&T’s Cash Flow Support Its Dividend?

Just think about all the things you do on your smartphone. You go online, stream and stay in touch with friends and family. Most people will pay their AT&T bill over many others, even in hard times. This makes AT&T a stable business with reliable earnings. AT&T’s cash flow is reliable, fluctuating largely because of how much the company invests in upgrading and maintaining its network.

AT&T’s free cash flow is its free cash earnings after investing in the business. Management expects AT&T to generate between $17 billion and $18 billion in free cash flow this year. The company spends roughly $2 billion on each quarterly dividend, which means it has an annual dividend expense of $8 billion. That’s just 45% of AT&T’s cash flow this year. AT&T’s business would have to see cash earnings drop enough that the company wouldn’t cover its dividend with cash.

Never say never, but it’s hard to imagine AT&T’s telecom business collapsing like this. Business is booming. The company added 349,000 net additions to its wireless business in the first quarter and believes its churn rate (how many customers leave) of 0.72% is the best in the industry.

The dividend is healthy and the future is bright

Retirees don’t have to worry about AT&T’s dividend. It is on solid financial ground now, barring an unforeseen disaster. AT&T’s dividend should become increasingly secure as the company continues to pay down debt in the coming years.

Plus, its momentum in the wireless business should translate into earnings growth. Analysts estimate that AT&T will grow earnings by an annual average of 2% over the next three to five years. That won’t rock your world, but it’s enough to forego occasional dividend increases without affecting the payout ratio.

I wouldn’t bet that AT&T Farm will outperform the broader stock market anytime soon, but retirees looking for a high dividend yield they can rely on should look no further.