Think of the things in your life that are ubiquitous.
Does your cell phone come to mind?
Look around you. Can you find anyone that doesn’t have/use a cell phone?
Phones – especially mobile phones – are a part of our everyday lives. And it’s unlikely that’s going to change anytime soon.
While it’s hard to predict which phone models are going to be popular this year or the next, it’s quite easy to see who’s going to provide the service those phones require, as there are only a few major carriers that operate here in the US.
As such, you have what basically amounts to an oligopoly of mobile service providers to choose from.
That makes for pretty fertile ground for both companies and investors to make plenty of money.
Even better, some of the biggest and best telecommunications companies here in the US pay out hefty dividends, and have pretty lengthy track records of increasing those payouts to shareholders.
Take AT&T Inc. (T) for example.
They’ve been increasing their dividend for the last 33 consecutive years.
And they’re able to keep increasing their dividend because they generate a lot of profit, and that profit is slowly increasing over time.
The reason their profit increases over time is because they provide a necessary service to millions of customers.
It’s a wonderful cycle, isn’t it?
AT&T Inc. is a holding company that provides domestic and international communication and entertainment services.
Everyone around you likely has a phone of some kind, and possibly even multiple phones (home and mobile).
In fact, you’d be better served trying to find someone who doesn’t own a phone.
The great news is that those phones come attached with recurring fees. You can’t just pick up and dial your friends or family for free. That phone call gets routed through a network – and the money is in the network.
As such, companies like AT&T spend lots of money building and maintaining their networks so as to continue collecting fees for their services.
And odds are pretty strong that they’ll be collecting fees for voice and data usage for many years to come, as people typically view a phone as a necessity. It’s gone beyond just a simple convenience. Phones are now considered an essential part of everyday life.
Furthermore, the rising popularity of smart phones means more and more people are accessing data and the internet on the go, which requires network access. That means, well, you guessed it: more money for AT&T and its shareholders.
Not only is AT&T one of the two major mobile voice and data providers in the US, but they also have a broadly diversified entertainment and content business.
The latter part of the business has been bolstered with the recent acquisition of DirecTV, which catapulted AT&T into a leading provider of pay TV services.
And they’re currently attempting to close an acquisition of Time Warner Inc. (TWX). This would transform the company into a totally vertically integrated entertainment conglomerate, with an ability to control the production and delivery of content, along with communication.
The growth story over the last decade is right about what you might expect for a large and mature company operating inside of a competitive industry that provides a utility-like service.
AT&T isn’t going to provide you with huge annual growth, but they don’t really have to.
First, let’s dig into what they’ve been up to over the last decade.
AT&T has increased its revenue from $118.9 billion to $163.8 billion between fiscal years 2007 and 2016. That’s a compound annual growth rate of 3.62%.
AT&T’s earnings per share advanced from $1.94 to $2.10 over this same stretch, which is a CAGR of 0.88%.
The reported GAAP EPS for the company can vary quite a bit from year to year, with the company routinely taking a number charges and adjustments that can cloud its true profitability.
That said, the cash flow is prodigious.
Looking forward, CFRA (a professional stock analysis firm) is anticipating that AT&T will compound its EPS at an annual rate of 3% over the next three years.
That’s more in line with what I think AT&T can really do over the long run, which would support like dividend growth.
This forecast factors in the full materialization of recent acquisitions, as well as the potential for Time Warner to transform the company (at the cost of a stressed balance sheet).
But where AT&T really shines is the generous dividend they pay and increase annually.
As noted earlier, the company has been paying an increasing dividend for more than 30 consecutive years.
That kind of record means they’re a “Dividend Champion”: a stock with at least 25 years of consecutive dividend raises, and included as such in David Fish’s Dividend Champions, Contenders, and Challengers document.
The CCC document tracks stocks with at least five years of consecutive dividend raises.
While AT&T hands out dividend increases year in and year out, the increases aren’t massive.
In fact, the 10-year dividend growth rate is just 3.7%.
More recent annual dividend increases have been even smaller, in the ~2% range.
But one should think of this stock like a utility.
The company provides a necessary and ubiquitous service. And the stock offers a monstrous yield with a lower-growth profile.
That monstrous yield, by the way, looks like this: the stock currently offers a very juicy yield of 5.2%.
There just aren’t many high-quality businesses out there that offer that kind of yield in this otherwise low-interest-rate environment.
In fact, you’d be very hard-pressed to find a high-quality dividend growth stock out there that’s offering a higher yield while at the same time offering this kind of dividend safety and growth.
Speaking of dividend safety, the payout ratio tells us a lot about that.
While the payout ratio using strictly TTM GAAP EPS looks quite high – that number is 94.2% – the company’s free cash flow is comfortably covering its dividend obligation.
AT&T’s most recently reported quarter showed $5.9 billion in FCF. The dividend ran the company approximately $3 billion over the same quarter.
So the dividend payout ratio is truly – or more accurately – closer to 50% than 100%.
And the dividend safety is likely only to improve as the potential from recent M&A activity (most notably the DirectTV acquisition) is fully realized by the company.
Indeed, the FCF payout ratio was ~70% using full FY 2016 numbers (the dividend payout against full-year FCF), yet we can already see a better cushion when looking at the most recent quarter.
Sure, the profit and dividend growth may lag some other opportunities out there, the large dividend gives a prudent investor plenty of current ongoing dividend cash flow to reinvest as they see fit (or even pay real-life bills).
The one aspect of the business that might be a bit of a drawback is the balance sheet.
The company, in my view, doesn’t have too much debt. But they still have plenty of it. And so the balance sheet could stand to be improved.
The long-term debt/equity ratio is 0.92; the interest coverage ratio is just over 5.
In absolute terms, AT&T is carrying around over $113 billion in long-term debt against relatively little cash. Meanwhile, that debt load will surely increase if/when the acquisition of Time Warner closes.
Profitability, however, is fairly strong for a utility-like business that offers services/products that are more or less commodities.
Net margin has averaged 8.32% over the last five years. Return on equity has averaged 11.52% over the same time frame.
AT&T offers a lot to like, which is why I personally have a fairly large position in the stock.
You’ve got a very healthy dividend that’s comfortably covered, a ubiquitous service, a prime player in an oligopoly, and a healthy US market where subscribers are willing to pay for data and mobile plans.
Furthermore, AT&T takes its responsibility to shareholders seriously: they returned almost $12 billion to shareholders in the form of a quarterly dividend last fiscal year.
And recent M&A activity could offer AT&T the ability to send even more cash shareholders’ way, which is something I’m certainly all for.
AT&T is quickly transforming itself into what will become one of the largest communications and entertainment conglomerate in the world, and it’ll be a business that’s highly vertically integrated.
However, there are significant risks to consider before investing here.
Primarily, it’s quite expensive to maintain a network of AT&T’s size. And they have to constantly upgrade the network to provide better and faster service to customers.
This is due to the very competitive marketplace. Although I previously mentioned we primarily have an oligopoly of providers here in the US, the competition among those select companies is extremely strong.
In addition, there has recently been a competitive push among much smaller, newer companies that pay for network access. These mobile virtual network operators (MVNOs) don’t actually own the expensive infrastructure and networks that AT&T has built, but instead pay to obtain bulk access to the networks to offer discount plans to their customers.
This provides extra revenue for companies like AT&T, but comes at the cost of potentially losing customers.
And the ongoing trend in “cutting the cord” could ultimately serve to undo some or much of the potential of AT&T’s ongoing shift into a vertically integrated entertainment giant.
Looking at the valuation, the stock is trading hands for a P/E ratio of 18.6.
That looks fairly cheap – it’s well below the broader market (22.5) and the stock’s five-year average P/E ratio (21.3) – but, as noted earlier, the company’s reported GAAP EPS can vary quite a bit from year to year.
I valued shares using a dividend discount model analysis.
I factored in an 8% discount rate and a long-term dividend growth rate of 3%.
That DGR is in line with the stock’s demonstrated long-term dividend growth rate, as well as the forecast for EPS growth looking out over the near term.
I think the expectation that AT&T can grow its business and dividend at ~3% over the long run is reasonable.
The DDM analysis gives me a fair value of 40.38.
Bottom line: AT&T Inc. (T) provides ubiquitous telecommunications and media delivery services, and the odds are very good that these services remain ubiquitous for quite some time. As such, I expect the company to continue profiting from society’s need to stay connected and access data on the go. And more profit means more cash to send shareholders’ way in the form of rising dividends. The potential for a vertically integrated conglomerate makes the business even more appealing. Finally, with a yield well above what the broader market offers, and quite a bit of possible upside via what might be undervaluation, investors would be wise to take a look at this stock here.
— Jason Fieber
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