Where to Next for AT&T, the Dividend Stock?
AT&T is a giant in the telecommunications sector, and the stock itself (T) is prominent to dividend investors investing for income. It has also been a matter of debate among investors as to whether it is a reliable long term investment, especially as the company has been subject to poor decisions, questionable investments, and an overwhelming quantity of debt over the years.
Ever since the new CEO John T. Stankey took over in July 2020, the new AT&T management has endeavored to address issues plaguing the company for years by making several bold decisions. For instance, in December, AT&T declared that it would maintain the dividend payment at $0.52/share. The company typically raises the dividend in December each year, with December 2019 being the last time AT&T hiked the dividend.
It places the 36 year-streak of dividend hikes under threat, and the decision has tempted investors to believe this is the end of the road for AT&T as a solid dividend stock. However, such a move by the management may well prove to benefit the company in the long run. Here is why maintaining the dividend, along with other bold decisions under the new CEO, make AT&T a compelling long term investment.
Significant Opportunity to Pay Off Long Term Debt
For a while, AT&T has been carrying burdensome debt loads, with the debt soaring to record levels of $190 billion in June 2018. The company’s acquisitions of DirecTV and Time Warner have both contributed to the alarming amount of debt AT&T holds. Both investments have proved to be undesirable over time. DirecTV has been consistently losing customers, and Time Warner has been flatlining.
However, since June 2018, the telecommunications company emphasized paying back as much debt as possible. As of September 2020, AT&T had approximately $158.88 billion in debt. This is a reduction in total debt by 16.45% since record highs were recorded in June 2018. Despite the blip in March-June 2020, AT&T has been persistent in whittling down the long-term debt, quarter after quarter.
With the management deciding not to raise the dividend in December, the company could utilize the additional cash flow to reduce the debt load. AT&T has the opportunity to make significant progress in this endeavor in 2021, considering that the company managed to marginally lower the total long-term debt in a pandemic-stricken year. With the enormous debt having long been a cause for concern for AT&T investors, the significant progress the company made in paying off the debt should alleviate such fears over the long run.
DirecTV Divestment Prospects
AT&T completed the acquisition of the satellite and cable company DirecTV in 2015. However, since being acquired for $63 billion, DirecTV has declined considerably. With consumers switching over from cable and satellite to streaming, the company’s consumer base has shrunk consistently over the last five years.
DirecTV has become a deteriorating segment of AT&T, with the number of consumers decreasing at an accelerating rate in the last couple of years, in particular. Thus, the divestment of DirecTV is an optimal decision made by the new management in the long run for AT&T. DirecTV has transpired to be a poor investment by AT&T, and the segment has been of minimal benefit.
As of December 2020, there have been reports that AT&T will endeavor to divest a majority stake in DirecTV. In the final bids, the favorites to buy the majority stake in DirecTV are Apollo Global Management and Churchill Capital, both of which are based in New York. The divestment provides the opportunity for AT&T to address the debt issue and seek better acquisition opportunities elsewhere.
AT&T’s share price, relative to its reported earnings per share (EPS), provides indications of trading well below its fair or intrinsic value. The P/E ratio demonstrates that AT&T is a stock that is significantly undervalued. According to Seeking Alpha, the company’s forward (next 12 months) P/E ratio is only 9.15 (as of January 20, 2020), well below the typical fair value P/E ratio of about 25.
One way the fair value of AT&T can be estimated is by utilizing the 4-Year Average Yield metric. The fair value estimate can be calculated by using the formula:
FVest = Share Price × Dividend Yield / 4Y Avg Yield
With a current yield of 7.18% and a 4-Year Average Yield of 6.22%, the estimated fair value share price for AT&T is approximately $33.43. Based on the fair value estimate, AT&T’s current share price is trading at a discount of about 13.37%. For the value investor, this would be an optimal entry point to invest in AT&T. Investing and holding shares of AT&T at current share price levels provides the incentive of potential double-digit returns, provided that the share price appreciates to fair value. This is without even factoring in returns from dividend payments and reinvestments.
Secure High Dividend Yield
Over the last few years, AT&T’s dividend yield has oscillated in that 5–7% range. More recently, the yield occasionally breached the 8% mark. It raised concerns among investors that AT&T’s dividend yield is approaching perilous levels and is in danger of being cut. These concerns have been emphasized much more due to the ongoing pandemic affecting the company’s performance.
However, the current 7% dividend yield is actually in no danger of being cut anytime soon, pandemic or no pandemic. In 2020, AT&T received at least $26 billion in free cash flow, which more than covered the full-year dividend payments. Based on 2020’s free cash flow, 57% of the cash flow was used for the dividend payments.
The payout ratio of 57% lies in the ideal range, and it is unlikely that a company with a payout ratio around this level would cut the dividend. Considering that 2020 was a pandemic-struck year and that the HBO Max prospect can potentially provide an immense cash flow boost, the payout ratio should be lower in 2021.
Overall Stock Rating
Considering the uncertainty over the 36-year dividend growth streak and AT&T’s share price being well below intrinsic value, for the investor eyeing consistent and rapid dividend growth, AT&T would be a HOLD only. With the company’s 5-Year Compound Annual Growth Rate (CAGR) just above 2%, this would not be an optimal dividend stock to buy into for the dividend growth investor. Thus, it would be ideal to hold the shares and apply the Dividend Reinvestment Plan (DRIP) for AT&T.
However, AT&T would be rated as a BUY at current share price levels for investors that seek value and target undervalued stocks. With AT&T share prices trading well below the fair value, investors that buy into the stock at current share prices could potentially receive double-digit returns in capital gains.
Overall, with the new management looking to address the long-term issues and the growth prospects of the company, AT&T the dividend income stock would not be a bad long term hold for investors that are focusing on receiving income and value, with not as much downside expected as much as upside considering its current valuations and the safety of the dividend.
Disclaimer: I am NOT a financial advisor! These articles are for educational and inspirational purposes only. In this article, I am only sharing my opinion, with profits or losses on investments not guaranteed! Please do your own research, with due diligence!
Disclosure: I am long MSFT, KO, T, MPW, O, ABBV, CSCO, PFE, and MRK.