Is AT&T's 5%-Yielding Dividend Finally a Buy for Passive Income?

AT&T (NYSE: T) has been a disappointing dividend stock in recent years. The telecom giant slashed its payout by nearly 50% in 2022 when it unveiled plans to spin off its media division to create Warner Bros. Discovery. The company made the move to retain additional cash to reinvest in its business and reduce debt. It had struggled to deleverage its balance sheet in the years following that cut, which caused concerns that the company might need to reduce its dividend again.

However, with leverage finally coming down in the past year and a clear line of sight for more deleveraging in the future, AT&T's 5% yielding dividend is on a much firmer foundation. Here's a look at whether it's now an attractive option for those seeking passive income.

Falling fast with an acceleration ahead

AT&T ended the second quarter with $126.9 billion of net debt, which put its leverage ratio at nearly 2.9 times. That was an improvement from the year-ago period, when it had $132 billion of net debt and a 3.1 leverage ratio. The company has been producing growing excess free cash flow after capital investments and dividends, which it has used to repay debt, to the tune of $1.9 billion of debt reduction in the second quarter and $5.1 billion over the past year.

The company expects to continue producing excess cash, which should allow it to reach a leverage ratio in the range of 2.5 in the first half of next year. Leverage should continue to decline in the future, especially after the company recently agreed to sell its remaining 70% stake in DirecTV to partner TPG. That deal, which should close in the second half of next year, will bring in an additional $7.6 billion of cash through 2029. The company plans to use those cash payments to strengthen its balance sheet further.

With its leverage ratio improving and further enhancement ahead, AT&T's high-yielding dividend is growing more sustainable.

Still behind its rival

While AT&T hasn't had to cut its dividend again since slashing it following the spinoff of its media business, it also hasn't been able to start increasing its dividend, either. That could change in the coming years, especially as it pulls forward cash through the sell-off of its stake in DirecTV. It could use that cash to further reduce debt, repurchase shares, and increase its dividend.

In the meantime, AT&T currently offers a bond-like fixed income stream, with its payout yielding around 5%. Contrast that with rival Verizon (NYSE: VZ), which has a higher dividend yield of around 6%. Furthermore, Verizon has steadily increased its dividend. It delivered its 18th consecutive annual dividend increase this year, the longest current streak in the U.S. telecom sector. While Verizon's raises have been modest, at less than 2% annually in recent years, it has at least given its investors a raise.

Verizon has been able to increase its dividend because it has a stronger financial profile. Its leverage ratio was down to 2.5 at the end of the second half, which is AT&T's target range for the first half of next year. Verizon's leverage ratio should continue to fall over the long term. Its long-term target is to get it down to a range of 1.75 to 2.0, though it plans to start allocating some capital to share repurchases once it's around 2.25. While Verizon's pending $20 billion all-cash deal for Frontier will delay its ability to achieve its targeted leverage ratio, it will have a lower level following that deal than AT&T has right now.

Not there quite yet

Given its higher yield, steady growth, and lower current leverage level, Verizon is the better option over AT&T for passive income right now. That could change over the next year. If AT&T's improving balance sheet puts it in the position to return more cash to shareholders by starting to increase the dividend and buying back stock, it would become a more attractive option for income investors.

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Matt DiLallo has positions in Verizon Communications. The Motley Fool has positions in and recommends Warner Bros. Discovery. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.