High debt burdens are one of the main factors to be aware of when trying to find safe dividend stocks (here are five other tips). AT&T expects its net debt-to-EBITDA ratio to hit 2.5 times one year after the deal closes.
However, AT&T has been here before. As seen below, courtesy of Bloomberg (2), AT&T’s key debt ratio has been at 2.5 or higher in the past. Bloomberg also noted that there are 159 companies in the S&P 500 with a net debt-to-EBITDA ratio greater than 2.5 times.
While the company’s debt burden is elevated, it doesn’t appear to be dangerous – especially in today’s yield-starved credit markets, which are eager to put capital to work. There is little chance AT&T’s debt gets downgraded from investment grade to junk status.
Despite higher financing costs and issuing more shares, AT&T also expects the deal to be accretive in the first year after it closes on adjusted earnings per share (EPS) and free cash flow per share basis.
The addition of Time Warner Inc (NYSE:TWX) would alter AT&T’s revenue mix as well (Time Warner would represent 15% of overall sales), hopefully improving AT&T’s growth profile and lowering its capital intensity at the margin.
Management also expects AT&T’s dividend coverage will improve. The 2.1% dividend increase over the weekend was an indicator that AT&T expects to generate plenty of free cash flow over the next couple of years to work down its debt and continue paying safe and (moderately) growing dividends. Dividend growth will likely remain between 1% and 3% per year.
All of this is fine and dandy over the near term. However, long-term investors must not forget that AT&T’s acquisitions of DirecTV and Time Warner give it meaningful exposure to two companies that are facing their own unique sets of disruptive challenges.
If industry conditions take an unexpected turn away from the direction AT&T has bet on in a big way or management becomes distracted (two very different cultures and businesses are combining), the company’s debt burden and refinancing risk could become a big deal within the next 5-10 years.
Closing Remarks
Major acquisitions come with great risk. AT&T Inc. (NYSE:T) has taken two large bites recently with its DirecTV and Time Warner acquisitions. Neither of these deals jeopardizes the near-term safety of AT&T’s dividend.
However, my preference is to watch major transformations from the sideline for a while. AT&T has a lot of new businesses to digest and optimize between DirecTV and Time Warner. The media industry could certainly evolve the way AT&T is expecting (and in part trying to force with its deals), but there are plenty of other risks involved as well. Certainly no one can forget AOL’s disastrous merger with Time Warner.
For now, I prefer to stick with other high dividend stocks in our Conservative Retirees dividend stock portfolio (3).
Disclosure: None
Additional Links:
(1) http://about.att.com/story/att_third_quarter_earnings_2016.html
(2) https://www.bloomberg.com/gadfly/articles/2016-10-26/debt-investors-might-want-to-worry-about-at-t
(3) http://www.simplysafedividends.com/portfolios/conservative-retirees/
