I recently gave a presentation at a financial convention in Orlando. I spoke about the power of dividends and how dividends can save your future. Afterwards, I took questions. The majority of those questions were about two telecommunications giants: AT&T stock and Verizon stock.
That’s fine. I only spoke about dividend stocks but I got a strange sensation that they would have asked me about those two stocks regardless of what I talked about. I could have gotten up there and divulged the secret to immortality and afterwards the same guy would have raised his hand and asked, “What do you think of AT&T (T)?”
I didn’t quite realize how widely owned and followed these two stocks are. They are likely core holdings in an awful lot of dividend stock portfolios. Although neither AT&T stock nor Verizon (VZ) stock are currently in the Cabot Dividend Investor portfolio, I will weigh in with an opinion on the desirability of the two investments right now in deference to the demand I’m sensing from dividend investors.
AT&T is one of America’s two largest telecom providers along with Verizon (VZ), with about a 30% share of the U.S. wireless market. But the company is no longer just a telephone company. Now, it’s a mega media conglomerate. The company’s $85 billion purchase of Time Warner last year got it into the content business.
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The business is now roughly composed by earnings of 40% wireless, 20% consumer entertainment (including DirecTV and other cable services, fixed line and internet), 20% fixed phone lines for businesses, 15% media (including HBO) and the rest in Latin American wireless and satellite TV.
I don’t like the focus on all those other businesses. Conglomerates tend to eventually start divesting themselves of noncore businesses to unlock shareholder value. And these businesses are mature and changing rapidly. Cable TV and fixed phone lines are quickly fading away as streaming services and wireless appear poised to make them obsolete. I know I won’t have cable TV or a fixed phone line in the near future. I’m not an outlier, as pay TV subscribership is down 22% since 2015.
Media content is good but it’s hard to predict where it’s going with the emergence of Netflix, Amazon Prime, Hulu and YouTube. And now AT&T has forked over $85 billion for Time Warner. Now, the company is laden with a massive $160 billion debt load while it also invests big on 5G technology.
Investors didn’t like the Time Warner acquisition either—the stock was down 22% for 2018 despite decent operating performance. Revenues grew 6.4% and earnings were 15.4% higher for the year. As well, the company anticipates solid free cash flow growth of 16% in 2019. At the same time, AT&T stock is trading well below its historic valuations with a massive 6.55% dividend yield. And with a payout of 60% of free cash flow, that dividend should be safe.
Under the circumstances, the stock should also hold up well if the market turns south. However, even with cash flow growth AT&T will need every bit of it to service the debt, build the 5G network and pay the dividend. Even if everything goes well, it’s hard to see how the company can deliver much in terms of capital appreciation. I wouldn’t rush to sell T stock if I already owned it … but I wouldn’t buy it here either.
Much of what is true about AT&T is also true of Verizon, with one key difference: Verizon didn’t delve as heavily into other businesses as AT&T. It is more focused on the core wireless business, where it has the biggest market share (40%) and higher profit margins than AT&T.
Verizon has also purchased other businesses including AOL and Yahoo. And those investments haven’t panned out. But the difference is that Verizon only shelled out $9 billion for these companies, a far cry from the $130 billion AT&T spent on DirecTV and Time Warner. Verizon also has a hefty debt load of $113 billion, but that is mostly from buying the other half of Verizon Wireless from Vodafone (VOD) years ago.
Verizon also has cable TV and fixed line businesses that are fading. However, the more honed focus on wireless enables them to do it a little better. And wireless subscriber growth has been much more impressive than AT&T’s. It’s also squeezing out better profits. Like AT&T, it will have to spend most of its cash flow on debt service, building out the new 5G network and paying the dividend, currently yielding a more modest 4.5%.
In all, AT&T is cheaper than Verizon, trading at 11 times earnings versus 13 times for AT&T stock. T also pays a better dividend yield, 6.55% versus 4.5%. But the price difference reflects AT&T’s expensive and unproven foray into those other businesses. Verizon pays a solid dividend that should be safe, which should help VZ stock hold up well in a down market.
If I had to choose between T and VZ, I would prefer VZ. I like the better wireless focus and the greater predictability of future earnings. However, because of modest earnings growth going forward and the fact that VZ is currently selling near the 52-week high, I wouldn’t buy it at current levels. I would, however, continue to hold it if I already owned it.
Tom Hutchinson, Chief Analyst of Cabot Dividend Investor, is a Wall Street veteran with extensive experience in multiple areas within the financial world. His advisory is geared to providing you both high income and peace of mind. If you’re retired or thinking about retirement, this advisory is designed for you.Learn More