On Tuesday afternoon, AT&T (NYSE:T) released its fourth-quarter results as Seeking Alpha has covered here. The stock is down a little after-hours, but we aren't worried. While investors could look at the results and interpret it many ways, there is only one number we are interested in as mentioned in this article. Free cash flow.
AT&T reported $3.1 billion in free cash in the fourth quarter of 2015, bringing the yearly number to $9.2 billion. The reason we are keen on this number is to gauge AT&T's ability to maintain, increase, and even substantially increase its dividends.
Now with two full quarters behind it after acquiring DIRECTV, this is how AT&T's dividend coverage looks from the free cash flow perspective:
- Shares outstanding is 6.15 billion, with about 1 billion shares added due to the DIRECTV purchase.
- The free cash flow in the two quarters so far have been $5.2 billion and $3.1 billion.
- Current quarterly dividend is 48 cents per share. Although this is the dividend for 2016, let's use the same number for the calculations below to show the worst-case scenario.
- Dividends consumed just 55% of the third quarter's free cash flow, while in the fourth quarter, it consumed nearly 95% of the free cash flow. For example, 6.15 billion shares times 48 cents/share means the company required $2.952 billion to cover the dividend payments in third quarter.
- Before you wonder how is 95% consumption good for shareholders, the same fourth quarter in 2014 generated $1.31 billion in free cash flow. The third quarter generated $3.36 billion. Shares outstanding were around 5.1 billion back then before the DIRECTV purchase added new shares.
- Using the then dividend of 47 cents per share, dividends consumed $2.40 billion. This number represented 71% and 183% of the free cash flows in the third and fourth quarters of 2014.
- Recent trend shows that the fourth quarter is AT&T's weakest in terms of free cash flow as can be seen here.
To summarize the points above, the DIRECTV merger has so far had a positive impact on AT&T's free cash flow. Even the historically weak quarter generated enough cash flow to offset the dividend payments, which means the other three quarters are likely to generate sufficient cash flow for operations, expansions and returns to shareholders.
In addition, as reported in the press release, the company is planning to launch more integrated video packages to exploit its recent content acquisition and the decision to bring back unlimited data plans. While the company is showing increase in subscribers across many categories (DIRECTV, Wireless, Mexico Wireless), it also reported lower churn rates of existing subscribers in the wireless category.
Conclusion: As one reader in our recent article commented, we are perhaps witnessing the transformation of AT&T right now. While it has been a major telecom player for long, we are also witnessing the company's foray into media and contents. This in turn makes the stock possess a unique combination of high yield, income appreciation potential, and growth potential. While we have a large position in AT&T already, we will be accumulating more as seen fit.
Disclosure: I am/we are long T.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.