In the midst of the carnage induced by the arrival of coronavirus to the U.S, which precipitated the March stock market crash, AT&T (NYSE: T) was amongst the losers. However, while the overall market recovered, with the S&P 500 up almost 10% YTD, the U.S telecommunications giant did not and remains down by over 25% since the beginning of the year. However, there are several reasons to be bullish for the stock’s prospects.
World-Beating Dividend
With a dividend of 7.3%, which is especially significant given that 10-year Treasury yields are below 1% and are expected to remain low for the foreseeable future, AT&T easily has one of the highest payments you can find in the S&P 500. Yet, despite fears of those such as Jim Cramer, AT&T differs from most other 5%+ yielding stocks. Having been raised every year since 1998, including a steady 1-cent annual raise every year since 2008 as you can see in the table below, and with a payout ratio below 60% of free cash flows (56.7% Q1-Q3 this year), AT&T’s dividend is safe.
This safety is supported by two key pillars. The first is that fears over its debt are overblown. After its $85 billion acquisition of Time Warner in 2018, AT&T won the questionable title of most indebted company in the world. However, since that acquisition, its debt has fallen by $31 billion, including $5.2 billion in the last two quarters. This has been driven by a shift in strategy away from profligate acquisition activity (with former CEO Randall Stephenson’s 13 year tenure seeing 43 acquisitions) towards offloading assets, with a sale of DirecTV likely. This shift will provide more cash to deleverage the company and will allow more focus on the company’s core business. This steady reduction in debt has been met with a reduction in average interest paid from 4.3% to 4.1%, a seemingly small drop that results in $300m/year savings. Decreases in interest costs are likely to continue in this low-rates environment as net debt continues to be reduced.
The second is that the reliability of AT&T’s income provides good reason to trust in the long-term future of its generous dividend. Monstrously high startup costs provide almost impregnable barriers to entry for its communications segment. This is coupled with extremely sticky, subscription-based income streams. AT&T’s churn rate (the proportion of users who disconnect from its services) for its Mobility Postpaid segment was just 0.85% in Q3, which is even lower than a still favourable ~1.1% rate, around which it had hovered for the past 4 years. Therefore, its healthy sub-60% payout ratio is unlikely to be dramatically threatened by either dangerous upticks in interest payment costs or falling income.
Solid Income Stream and Growth Potential
Now, there is, of course, little benefit of a 7.3% dividend when capital depreciation exceeds that. However, this is not seen as likely by most analysts (3 ‘sell’, 17 ‘hold’, and 9 ‘buy’ ratings), with the average target price of $32.21 representing an 11% increase from current prices) and for good reason. As one of only 3 U.S providers of 5G (Verizon and T-Mobile being the others), AT&T stands to benefit from wireless subscriber growth, especially with its recent offering of Apple’s 5G-connected iPhone 12. Increased work-from-home and ‘internet of things’ growth are two other trends providing potential tailwinds for subscription revenues. What is more, compared to Verizon, AT&T trades at low forward P/E multiples (9.1 vs 12.3). This is despite having higher growth in market share of the crucial wireless subscriptions market (up 2.8% vs down 0.2% in Q1 2020 YoY), a fact that provides justification for the belief that AT&T is relatively undervalued.
What is more, this year’s launch of HBO Max, which has accumulated 57 million worldwide subscriptions, provides potential for growth as it competes with Netflix and Disney+. Although, it must be stressed that HBO as a whole contributes less than 5% of AT&T’s revenues, so disappointments here would not cancel out the main communications segment.
Defensive Pick
It would be delusional to expect wild returns from AT&T. However, what you do receive, in what has recently been a volatile market with multiples at long-term highs, is a company with a robust income stream and the potential for decent capital appreciation. This is supplemented by one of the best dividends in terms of both yields and safety available anywhere in the U.S equity market. The last time AT&T was below $30/share was the beginning of 2012 and therefore there is the potential to enter at historically low prices.
The Sweeney Club 