AT&T (NYSE: T) just produced its latest earnings for Q3 on Oct. 21and investors were not that impressed. As can be seen from its Highlights page, the company produced lower revenue (partly due to a spinoff of DirectTV) as well as lower Cash Flow and Free Cash Flow.
But more disturbing than anything else was the fact that management, when directly asked by an analyst, refused to give any clarity about the future dividend.
AT&T's Dividend Issues
AT&T shareholders will own 71% of the combined company. So far, AT&T has not announced exactly how those shares in the combined company, which will be named Warner Bros. Discovery, will be issued to AT&T shareholders. In addition, it will not likely close until sometime in 2022.
As part of that plan, AT&T said it would cut the dividend, in order to pay down debt, as long as the spin-off deal goes through. Here is exactly what management said in the presentation:
"After close and subject to AT&T Board approval, AT&T expects an annual dividend payout ratio of 40% to 43% on anticipated free cash flow of $20 billion plus."
That implies the dividend cost will fall from about $15.05 billion now to between $8.0 billion and $8.6 billion. This implies a dividend cut of between 42.9% and 46.8% from today's level.
In other words, the $2.08 per share annual dividend could fall to between $1.11 and $1.19. That works to an average of $1.15 per share or 55% of the present dividend.
Cut To Now
Since May, management has provided no further guidance about the potential dividend cut. Since May, AT&T stock has deteriorated, as you can see in the chart below.
In fact, it peaked out this year at $32.63 on May 10. But since then, as of mid-day Oct. 22, it is down to $25.57. That is a drop of 21.6% from its peak.
The problem is, it is not going to rise anytime soon. Here's why.
The Math of the Cut
Right now, the stock has a dividend yield of 8.14%. That can be seen by dividing $2.08 by its price of $25.56.
But investors anticipate the dividend could fall to $1.15. At today's price, the yield would be 4.50%.
However, this is not likely to be the final yield. Even with a 5.75% yield in the future, this implies AT&T stock will have to fall to $20.00. This can be seen by dividing $1.15 by 5.75%. This represents a further decline of $5.56 from today's price or 21.75%.
In fact, Seeking Alpha shows that in the past four years the stock has had an average yield of 6.43%. At that yield, with a $1.15 dividend, the stock will fall to $17.89. That represents a decline of $7.67 from today.
Here is where things get complicated mathematically.
Since we know that the Warner Bros. Discovery stock spin-off is going to occur, this will result in an automatic cut in today's price. In the past management has said that the value of the spin-off would be about $7.00 in value per AT&T share.
So if we subtract $7.00 from $25.56, we get $18.56. That implies that the post-spin-off yield will be 6.20% (i.e., $1.15 / $18.56).
The yield will actually be higher than this if the value of Warner Bros. Discovery will be $8.00 per share.
So, in effect, at today's price, the yield is about 6.20% post-spin off. This is close to the average of the past 4 years.
What Management Said Recently
The CEO, John Stanky, did not directly answer the question on Oct. 21, when asked about the future dividend policy. Here is exactly what he said:
"a little further along in that process and we have some degree of visibility."
After that, he said the company reevaluate things:
"...we can step back at that moment, look at where the stock price is, how things are standing in the market at that point in time. And we're starting to get down to that window where people would need to make a decision, then we'll be giving you some visibility around what we think the right path forward is around that."
So things will stay nebulous until the company can see whether the spin-off deal will be approved and what the value per share of that spin-off will be.
What Investors Should Do
This leaves a large amount of uncertainty to existing AT&T investors. Nevertheless, as investors can see from my math, the stock trades approximately at a 6.20% dividend yield after taking into account the spin-off of Warner Bros. Discovery.
But there is no guarantee about this. The dividend could be set lower. The value of the spin-off could be lower. That would imply that the stock would have to fall even further. In either case, the lack of clarity is going to weigh on the stock price.