Sky-High Debt Is a Red Flag for AT&T Stock

Ahead of its quarterly earnings report, there is no denying that AT&T (NYSE:T) stock is very cheap. For example, it has a 7.6% dividend yield and a forward price-earnings ratio of just 8.5 times. Those are excellent numbers — but its upside for AT&T stock might be limited.

Image of AT&T (T) logo on a grey storefront

Source: Jonathan Weiss/Shutterstock

Investors seem to acknowledge this. Why do I say that? Well, AT&T stock has not had a very good year. It is down 30% over the last year, and down similarly year to date.

Moreover, in the past five years the stock has fallen 19%. Who wants to own a stock, no matter what the dividend is, and see it drop over a five-year period? No one. So that could be a major reason why it is so cheap.

AT&T will report its earnings on Oct. 22. Investors and analysts are not expecting quarterly numbers to come in much higher. That may be a downward catalyst on AT&T stock.

AT&T: All About the Financials

Another reason why AT&T stock is cheap may be its huge debt load. Although the company has $17 billion in cash, it is burdened with $168.6 billion in current and long-term debt. That is so high it is more than 86% of its $190 billion market capitalization. This figure also does not include $23.9 billion in capital leases.

Most of that debt came from its acquisition of DirecTV Now. This has caused huge and unnecessary interest payments which crushes its earnings power. Moreover, it presents an existential risk should interest rates every rise sharply. Moreover, the pay TV service has actually been losing clients, according to The Wall Street Journal.

Fortunately the company still produces positive free cash flow (FCF). In the last 12 months to June 30, the company made over $25 billion in FCF. That is more than sufficient to cover the dividend payments which only cost $14.9 billion.

Therefore, the dividend looks reasonably secure. The problem is the company needs that money to dramatically reduce its debt load. As a result, it may end up having to sell a lot of assets.

Hedge Funds Are Upset

Over a year ago, Elliott Management took a $3.2 billion stake in AT&T, roughly a 1% stake at the time. The activist group tried to get AT&T to change its ways. So far, the stock has not gone anywhere — in fact, it is actually down by about 28%-31%.

Elliott Management signed a standstill agreement in October 2019. Elliott Management has continued to push AT&T to reduce its debt.

When the financials come out on Oct. 22, we will be able to see how much debt has fallen in the past year. In September 2019, the company had $169.8 billion in debt. So, by Q2 2020, total debt had fallen by just $1 billion or so. I cannot image that Elliott Management is too happy about that. Maybe the results in Q3 will be better.

I suspect that the hedge fund might become more vocal again about the company’s performance.

What to Do With AT&T Stock

The company is forecast to report earnings per share (EPS) of 76 cents per share for Q3 on Oct. 22. That would be down over 19% from last year when it earned 94 cents per share.

However, this is still high enough to cover the 52-cent quarterly dividend. That is of some comfort.

I suspect that most investors will want to see how the HBO Max subscriber growth is progressing. They will also want to know about AT&T’s 5G wireless service and how that is progressing.

Investors will also look to see if the company is going to sell its DirecTV service. That could significantly reduce its debt, which I pointed out above is hurting the AT&T stock price.

However, unless AT&T can find a way to turn its earnings around and show major financial changes, I suspect that the upside is limited. I would look to purchase shares only if AT&T stock gets significantly cheaper from these levels.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.  

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