NEW YORK (CNN/Money) -
AT&T should cut its big, fat, juicy dividend.
I realize that may sound like heresy. After all, Ma Bell's stock is hovering near its 52-week low and many argue that the only thing preventing it from falling further is the dividend.
It currently costs AT&T (T: Research, Estimates) about $750 million to pay a dividend of 95 cents a share to all its shareholders. That may not seem like a substantial amount of dough for a company expected to generate $30 billion in revenue this year.
But every penny counts for AT&T these days since it is a company faced with a challenging (to say the least) future. Competition is fierce in the consumer long distance business and the corporate market isn't much healthier. AT&T needs to invest in the future.
Consider this: AT&T's dividend yield is now a whopping 6.7 percent, well ahead of the yield for Baby Bells Verizon (VZ: Research, Estimates), SBC (SBC: Research, Estimates) and BellSouth (BLS: Research, Estimates).
What's more, AT&T's dividend payment is substantially higher than what the company is expected to earn this year and next. According to First Call, analysts are forecasting earnings of just 52 cents a share this year, giving AT&T a payout ratio (dividend divided by expected earnings) of 183 percent.
"Certainly it's odd to see a dividend that's more than expected earnings per share," said Patrick Comack, an analyst with Guzman & Co. By way of comparison, BellSouth's payout ratio is just 54 percent, Verizon's is 63 percent and SBC's is 86 percent.
Ma Bell needs to stop living in the past
Sure, AT&T has done an admirable job of fixing its balance sheet lately. As of March 31, Ma Bell had net debt (debt minus cash) of $8.4 billion, down from $10.1 billion at the end of 2003 and $13.2 billion at the same time a year earlier.
| As of July 8, 2004 | | Source: Thomson/Baseline |
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What's more, the company generated $800 million in free cash flow in the first quarter of this year, which is more than enough to pay for the annual dividend.
But it's somewhat sad that AT&T's dividend yield is now so high that you could almost mistake the shares for being a junk bond.
Plus, AT&T may be able to handle the dividend payment this year. But for how much longer? Analysts expect Ma Bell's sales to drop 7.5 percent in 2005 and earnings to plunge more than 80 percent to just 10 cents a share.
"It's almost a certainty that the dividend is going to need to be cut. You can't keep the current dividend level with falling revenues and falling net income," said Greg Gorbatenko, an analyst with Marquis Investment Research.
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A spokesman for AT&T would not comment on speculation about its dividend.
But if AT&T slashed the dividend drastically, say to 25 cents a share, it would save about $550 million a year -- money that it could use to pay down more debt and/or to further invest in new technologies such as Internet phone calls, known as voice over Internet protocol (VoIP).
AT&T is latching on to the VoIP wave, having begun to roll out its CallVantage Internet phone service to residential consumers this year. But it probably should be even more aggressive since Internet phone calls will enable AT&T to drastically lower its cost structure.
Could T be another Kodak?
Of course, if AT&T cut the dividend, it risks incurring the ire of all the widows and orphans that own Ma Bell mainly for its predictable income stream. And that could cause the stock, already down 28 percent this year, to fall even further in the short term.
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Despite its big yield, many investors have hung up on AT&T.
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"A dividend cut is not built into the stock price. If AT&T were to cut the dividend it would be a disaster," said Comack.
But AT&T shouldn't simply appease yield-hungry investors. It should think of the future if it wants to have any chance of surviving.
A dividend cut could help AT&T transform itself from a stodgy long-distance company to one that is taking part in some of the more exciting, higher growth areas of telecom. Protecting the current dividend is pretty much an admission that the game is over.
"Fundamentals continue to deteriorate. AT&T has to find a way to offset losses in the consumer market," said Rick Black, an analyst with Blaylock & Partners.
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Now I'm not suggesting that Ma Bell give up the dividend entirely. If AT&T followed my example and cut the dividend to 25 cents a share, the yield would still be an attractive 1.8 percent (based on the current stock price), ahead of the average dividend yield of 1.5 percent for the companies in the S&P 500.
AT&T could also look to what's happened to fellow Dow exile Eastman Kodak (EK: Research, Estimates) as somewhat of an inspiration. Kodak bit the bullet in September, announcing a 72 percent dividend cut, in order to invest more in digital photography and medical imaging technologies.
The stock did plunge 18 percent the day of that announcement. But shares have since bounced back 18 percent. Of course, it's premature to say whether or not Kodak's turnaround will be an ultimate success.
Nonetheless, Kodak's management has to be encouraged that the stock isn't continually hitting new 52-week lows. It bottomed shortly after the dividend cut as investors took solace in the fact that Kodak is making an attempt to remain relevant.
And even after the cut, Kodak sports a healthy yield of 2 percent. So Kodak investors are still getting a decent chunk of income.
AT&T should take note.
Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies.
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