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Dividend Aristocrats In Focus Part 56: AT&T


Updated on January 22nd, 2020 by Bob Ciura

AT&T (T) is a widely-followed stock among income investors, and for good reason. The stock has a high dividend yield above 5%, and a long history of steady annual increases.

The company has increased its dividend payout for 36 consecutive years, making it a member of the prestigious Dividend Aristocrats, a group of S&P 500 stocks with at least 25 consecutive years of dividend increases.

Including AT&T, there are currently 57 Dividend Aristocrats. You can download an Excel spreadsheet of all 57 (with important metrics that matter) by clicking the link below:

 

AT&T is a strong business, with a leadership position across multiple areas of the telecommunications industry. It is also building on a huge growth catalyst, the massive acquisition of Time Warner.

AT&T continues to rank highly among the hundreds of stocks in our coverage universe, and also among the Dividend Aristocrats. We believe that the stock remains a strong buy for 2020 and beyond, due to its high expected returns.

Business Overview

AT&T traces its roots back to 1876 when Alexander Graham Bell invented the first version of the telephone. In its current form, AT&T is the result of a tangled web of mergers and spinoffs that have taken place since 1984, when the former AT&T spun off its local telephone operations but retained its long distance, R&D and manufacturing segments. SBC Communications was born from this and with it, the modern AT&T was as well.

SBC acquired several smaller telecommunications players, including what was left of AT&T in 2005, creating the company we know today. Since then, AT&T has diversified away from phone service with its DirecTV acquisition in 2015, and the 2018 acquisitions of AppNexus and Time Warner Inc.

Today, AT&T is the largest communications company in the world, operating in four distinct business units: AT&T Communications, which provides mobile, broadband, video and other communications services to more than 100 million U.S. consumers and more than 3 million businesses; WarnerMedia which includes Turner, HBO and the Warner Bros. studio; AT&T Latin America which offers pay-TV and wireless service to 11 countries.

The company generates roughly $170 billion in annual revenue. AT&T’s market capitalization today is nearly $280 billion, making it a mega-cap stock.

AT&T reported third-quarter earnings on October 28th. For the quarter the company generated $44.6 billion in revenue, down from $45.7 billion in the year-ago quarter, as declines in legacy wireline services, WarnerMedia and domestic video were partially offset by growth in strategic and managed business services, domestic wireless services and IP broadband.

Source: Investor Presentation

The core Communications Segment led the way for AT&T, particularly in the Mobility and Entertainment Group businesses. AT&T’s Mobility and Entertainment segments both generated EBITDA margin expansion for the quarter. Wireless service revenue increased 0.7% last quarter and 1.9% through the first three quarters, driven by 255,000 phone net adds. AT&T also reported a low postpaid churn rate of 0.95% for the quarter.

This led to strong financial performance overall. Net income came to $3.7 billion or $0.50 per share versus $4.7 billion or $0.65 per share prior. On an adjusted basis, earnings-per-share equaled $0.94 compared to $0.90 previously for a 4.4% increase. Adjusted earnings-per-share increased 0.4% year-over-year, resulting in a slightly higher adjusted operating income margin.

Source: Investor Presentation

Over the first nine months of 2019, AT&T generated 9.5% revenue growth, as 11% growth in services more than offset a 4.4% decline in the much smaller equipment business. AT&T is a cash cow–the company produced $21 billion of free cash flow over the first three quarters of the year.

This allowed the company to return significant amounts of cash to shareholders, including $11.1 billion of dividends paid over the first three quarters. AT&T also repaid $24.4 billion of long-term debt through this period. A reduced debt load will help free up additional cash flow for AT&T to continue investing in growth initiatives.

Growth Prospects

Along with its recent earnings results, AT&T also provided a 2020 outlook and 3-year financial guidance and capital allocation plan. For 2020 the company expects revenue growth of 1% to 2%, adjusted earnings-per-share of $3.60 to $3.70 and a dividend payout ratio in the low-50% range.

By 2022, AT&T expects 1% to 2% revenue growth, $4.50 to $4.80 in earnings-per-share (representing roughly 10% annual growth), continued dividend increases making up less than 50% of free cash flow, and a net-debt-to-adjusted EBITDA ratio of 2.0x to 2.25x.

Source: Investor Presentation

AT&T also forecasts free cash flow of $30 billion to $32 billion by 2022. The company will use the remaining cash after dividend payments to buy back ~70% of the shares issued for the Time Warner acquisition, as well as retiring 100% of the debt issued in the transaction.

Aggressively paying down debt is especially important for AT&T, as the company took on a huge level of debt to finance its massive Time Warner acquisition, as well as other bolt-on deals in recent years. AT&T ended the most recent quarter with $153.57 billion in long-term debt, although this represents a reduction from $166.25 billion at the same point last year.

Fortunately, AT&T generates huge cash flow which will keep the overall debt load manageable, as evidenced by the reasonable leverage ratios the company has targeted. In turn, we also expect the company to report steady growth going forward, as it has done for many years. AT&T is a colossal business, but it is not a fast grower.

From 2007 through 2018 AT&T grew earnings-per-share by 2.2% per year. While the company is picking up growth opportunities, notably in its recent acquisitions of DirecTV and Time Warner, we recognize the sizable debt incurred as well as the declines in certain legacy businesses. While the company put out strong growth expectations through 2022, we forecast 4% annual EPS growth.

AT&T’s enormous acquisition of Time Warner has already begun to pay off.

Source: Investor Presentation

While WarnerMedia segment revenue declined 4.9% year-over-year, due to a very unfavorable comparison period from a strong movie slate in the year-ago quarter, it did generate nearly 11% revenue growth at HBO. In addition, the WarnerMedia segment produced operating income margin expansion of 90 basis points for the quarter.

5G rollout is an additional catalyst for AT&T’s wireless segment. AT&T currently offers two separate forms of 5G service. The “low band” offers broad coverage for consumers and businesses, and is ideal for mobile customers. AT&T also offers a service called 5G+ which caters to high-traffic sites like stadiums and college campuses.

Management expects 5G device adoption to be a big factor in the company’s 1%-2% total revenue growth forecast for 2020. In December, AT&T rolled out its “low band” 5G service to 10 new markets, including Los Angeles, San Diego, San Francisco, Milwaukee, and Pittsburgh. The company plans to bring 5G to additional cities, with the goal of reaching nationwide coverage in the first half of 2020.

Overall, AT&T reported another strong quarter, and should continue to grow revenue and earnings through a number of positive catalysts. We think this is key for AT&T’s profitability and growth moving forward, and the financial results over the first three quarters of 2019 show not only that AT&T’s focus on costs is working, but also that its newer lines of business are driving growth.

Competitive Advantages & Recession Performance

AT&T has a competitive advantage with its entrenched position in various important industries. Although this position could be eroding due to technological change, it remains that the company has direct contact with 170 million customers.

AT&T is also a recession-resistant business. As a telecom provider, AT&T enjoys steady demand, as consumers are extremely reluctant to give up their broadband and wireless service, even during recessions. We view AT&T as among the most recession-resistant Dividend Aristocrats.

AT&T’s earnings-per-share during the Great Recession are below:

AT&T did see its earnings decline during the Great Recession, but at a modest rate. The company remained highly profitable during the recession, which allowed it to continue growing its dividend throughout. And, AT&T eventually eclipsed its pre-recession earnings level by 2016. It has kept on a strong earnings growth trajectory in the years since.

Valuation & Expected Returns

We continue to expect very strong returns for AT&T in the coming years due to a variety of factors. AT&T is among the most attractive Dividend Aristocrats right now, particularly for income investors.

We expect ~4% annual earnings-per-share growth over the next five years. Modest revenue growth will boost EPS, as will cost reductions to drive margin expansion. In addition, we expect revenue growth from WarnerMedia, as well as stronger performance from wireless services.

Additional shareholder returns will accrue from the combination of the stock’s high dividend yield and the change in the valuation multiple. The company’s annual dividend is now $2.08 per share, putting the current yield at 5.3%. That makes AT&T a premier income stock. In addition, the payout ratio is less than 60% of projected earnings for 2019, so we believe AT&T’s dividend is highly secure.

Lastly, we view the stock as slightly undervalued. Shares trade today at just 10.7 times our 2019 earnings-per-share estimate of $3.65. That is near the lowest price-to-earnings ratio the stock has seen in the past decade. In the past decade, AT&T stock traded with an average price-to-earnings ratio between 12 and 13.

Our fair value estimate is a price-to-earnings ratio of 12. If AT&T stock expands from the current P/E multiple of 10.4 up to our fair value estimate of 12, it would boost annual shareholder returns by 2.3% per year through 2025.

Combined with expected EPS growth of 4% and the 5.3% dividend yield, total returns are expected to reach approximately 11.6% per year through 2025. This makes AT&T one of our top-ranked Dividend Aristocrats, in terms of total expected five-year returns.

Final Thoughts

AT&T is a high-quality business. The company is steadily profitable, even during recessions. It also has a major growth catalyst in the form of its Time Warner acquisition. These qualities should allow the company to continue raising its dividend every year, as it has done for over three decades.

Debt remains a concern for investors, but the company’s immense free cash flow, in our view, diminishes the importance of this concern. Non-core asset sales will also aid in deleveraging.

Thanks to expected earnings growth, the high dividend yield, and a reasonable stock valuation, we believe AT&T can provide attractive total returns to shareholders in the coming years. As a result, AT&T stock remains a buy for income and value investors.

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