This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
AT&T Inc. (T) has long been known as a stodgy telephone company and, considering the company can trace its roots back to Alexander Graham Bell and the invention of the telephone, this isn’t very shocking.
However, AT&T has taken steps in recent years to diversify itself from slow-growth businesses, and redirect its business model toward growth.
AT&T has made several acquisitions that should position the company as a diversified telecom giant, which should provide support for a dividend yield of almost 7%. This article will look at why AT&T is one of our favorite Dividend Aristocrats to buy right now.
AT&T’s Competitive Advantages
The Dividend Aristocrats are a group of 65 stocks in the S&P 500 that have raised their dividends for at least 25 years. Companies don’t reach at least a quarter-century of dividend growth without competitive advantages that set them apart from peers. AT&T possesses numerous competitive advantages.
First, the company remains among the largest communications companies in the world, supplying phone, internet and video services to consumers and businesses alike. The company provides services to more than 100 consumers and nearly 3 million businesses in the U.S. This is a massive customer base that allows the company to keep prices competitive.
Telecommunication companies tend to offer similar pricing plans so as to keep customers from switching carriers. Price wars tend to disrupt business so AT&T and the other names in the sector largely avoid drastically reducing prices in order to gain market share.
Next, AT&T’s business has proven recession-proof. While consumers will cut expenses during recessions, they are much more likely to keep their phone and media services. This is reflected in the company’s performance during the “Great Recession.” Earnings-per-share decreased 23% from 2007 to 2009, but returned to growth the very next year. It did take AT&T until 2016 to make a new earnings-per-share high, but the company had grown its bottom-line every year from 2011 through 2019 before the COVID-19 pandemic negatively impacted its financial results in 2020.
Lastly, perhaps the most significant advantage that AT&T possess is the amount of content it can offer consumers. The company completed its $85 billion ($108 billion including debt) acquisition of Time Warner in 2018. While this purchase caused AT&T’s balance sheet to swell to $180 billion of total debt, it appears to have been worth it as AT&T diversified its core business and the company now counts Turner, HBO and Warner Bros. Studios among its assets.
The acquisition provided AT&T a large number of potential new customers, as there isn’t necessarily overlap between phone and content customers. For example, AT&T announced that its HBO Max streaming service now has more than 44 million U.S subscribers, a figure it had hoped to reach almost two years from now. The service has 64 million subscribers worldwide.
AT&T was looking for a buyer for its DirecTV business, but, finding it difficult to unload the asset, has decided to spin off DirecTV, along with AT&T TV and U-verse video, into a separate company. AT&T will maintain a majority stake in the new company, but will sell a 30% stake for $8 billion. This capital will be used to reduce debt.
AT&T last raised its dividend for the February 3, 2020 payment, giving the company 36 consecutive years of dividend growth. Traditionally, AT&T has raised its dividend for the first payment of the year, but shareholders have received the same amount for six consecutive quarters, including the already announced upcoming payment scheduled for May 3, 2021. A raise anytime this year will allow the company to keep its dividend growth streak intact.
The company’s annualized dividend is $2.08. We expect the company to earn $3.20 in 2021, resulting in a projected payout ratio of 65%. The payout ratio looks to be reasonable, especially when compared to the payout ratio of 68% that AT&T has averaged since 2011.
Examining free cash flow also shows that AT&T’s dividend appears to be quite safe. The company distributed $16.9 billion of dividends last year while generating free cash flow of $27.5 billion for a payout ratio of 61%. This is nearly in-line with the three-year average payout ratio of 57%.
Of course, debt can always pressure a dividend, but AT&T has reduced its balance sheet. As of the first quarter of 2021, total long-term debt stood at just under $161 billion, a sizeable reduction in obligations from just a few years ago. AT&T has also divested non-core assets to help pay down its debt, such as its recent DirecTV transaction.
The company expects free cash flow of approximately $26 billion in 2021, which should provide much of the capital needed to meet obligations that mature over the next twelve months. Shares yield 6.7% today, more than four times the average yield of the S&P 500 index.
AT&T trades at approximately 31 per share at the moment. Using expected earnings-per-share for the year, the stock has a forward price-to-earnings ratio of 9.7.
We believe that a multiple of 11 times earnings, below the long-term average, for 2026 is a reasonable target given the slow growth nature of the company’s business. Reverting to this target multiple could mean shareholders see a 2.5% tailwind to total annual returns over this period of time.
Total returns would also include earnings growth and dividends. Therefore, annual returns would consist of the following:
- 3% earnings growth
- 7% dividend yield
- 5% multiple expansion
Altogether, we project AT&T to provide a total return of 12.2% annually through 2026.
AT&T has expanded its business to include media content. The company did increase its debt position to do so, but has already taken steps to improve its balance sheet.
AT&T generates an enormous amount of free cash flow that more than covers dividend payments and can be used to pay down debt as well. The high yield appears safe even if dividend growth is likely to remain very low.
With an expectation of double-digit annual returns including a nearly 7% yield, AT&T earns a buy rating from Sure Dividend.