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AT&T (T) reported positive earnings on April 20, but investors were concerned about the low level of its free cash flow. The stock dropped by over 10% to $17.65 per share by the end of the day. Nevertheless, its $1.11 per share dividend looks to be secure, making its 6.29% ($1.11/$17.65) yield still attractive to investors.
The company said its free cash flow (FCF) was $1.0 billion, which was disappointing to some investors. For example, the dividend costs just over $2 billion, leaving cash flow negative after the dividend.
However, the reasons can be seen in the table below from AT&T. It was from the low level of FCF was due to abnormally high vendor financing, smaller distributions from DIRECTV, and a $1 billion reduction in operating cash flow during the quarter compared to last year.
The good news is that AT&T has a much lower dividend requirement compared to last year, when it cost $3.75 billion, compared to $2 billion this quarter. However, investors should not be too concerned about it.
This is because, as DM Martins Research pointed out in their analysis, the CFO, Pascal Desroches, said during the earnings call this lower level of FCF was due to a one-time set of events. He said there were "several seasonal and anticipated working capital impacts" or headwinds.
The CEO also said that he still expects full-year FCF will be $16 billion based on AT&T's internal projections. That is more than enough to cover the $8 billion annual cost of the dividends. Here is what he said exactly:
“We remain confident in our full-year outlook for free cash flow of $16 billion or better. This expectation is largely due to the timing of capital investments, device payments, and incentive compensation, which all peaked in the first quarter.”
These are statements the CEO did not make lightly, as he knows investors would be trying to figure out if the dividend was secure.
Where This Leaves Investors In AT&T Stock
As a result, investors can rely on the fact that its $1.11 annual dividend will keep being paid. That gives the stock, at $17.65 per share, a 6.29% dividend yield. Moreover, analysts still project $2.63 per share, putting T stock on a forward price-to-earnings multiple of just 6.7x earnings.
That makes it one of the cheapest multiples it has ever had in the last 5 years. For example, Morningstar says that its average multiple has been 8.7x over the last 5 years. That means if AT&T stock were to trade at this multiple, the stock price should be $22.88, or 29.6% higher.
Moreover, astute investors can take advantage of this in the options markets, by shorting out-of-the-money (OTM) put options. For example, the May 19 expiration put option chain, 28 days from now, shows that there is an attractive strike price and put premium. The $17.00 put strike price trades for 18 cents per contract.
That means that if the stock were to fall by 65 cents or 3.6% in the next month, the investor must purchase AT&T stock for $17.00. However, in the meantime, the 18 cents received from shorting the $17.00 strike price makes the yield-to-strike worth 1.06%.
Moreover, if the strike price is exercised the net investment cost is just $16.82 per share or 4.7% below today's price. That makes the investment in T stock very cheap indeed. In fact, at that effective buy-in cost provides a dividend yield of 6.60% (i.e., $1.11/$16.82).
This is on top of the high yield that T stock already has. In effect, this short-put trade is a structured way to average cost down into AT&T stock for long-term investors. Given that the dividend looks secure, value investors will likely take advantage of this high-yield opportunity.
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