Despite a solid last quarter, AT&T's (T) stock continues to be stuck at rock-bottom levels. I consider this to be an outstanding entry point for what's been one of the best dividend stocks over the past 25 years. AT&T's dividend yield is more than 6.5% on an annual basis, which is near an all-time high and more than any other stock with a market cap greater than $100 billion. What's better is AT&T produces plenty of free cash flow to maintain and continue growing this payment. I also like that AT&T trades cheap based on multiple fundamental approaches including historical multiples, a comparables analysis, and a discounted cash flow model.
The dividend has been provided uninterrupted since 1984 and increased every year since 1998 (20 years). As you can see by the chart below, AT&T's yield is at the upper end of its historical range. There are no issues with AT&T's performance and interest rates are still comparatively low, so I consider this a strong indication the stock is deeply undervalued.
In terms of dividend coverage, AT&T's payout ratio is at 66% (year-to-date), which is close to the company's average for the last couple of full years. This means there's plenty of room to continue growing the dividend payment and also plenty of room for safety should performance deteriorate. 2019 will be the first full year of performance after the Time Warner acquisition and I expect the dividend to continue looking solid.
AT&T's yield (6.56%), payout ratio (66%), and max yield (9.9%) also compares favorably to other large-cap high dividend stocks (note - max yield assumes each company pays out 100% of its annual free cash flow):
Based on historical valuation multiples, AT&T's valuation looks like a bargain across the board: (Data sources: Ycharts & Reuters):
Not only do those valuations look good relative to the last 5 years, AT&T's P/S and P/E ratios look well-valued over a longer time span too. Over the last 20 years, these valuations were only at this level during the last recession and tech bubble.
If you had to choose one large-cap stock in the telecommunications industry, it's generally going to come down to AT&T or Verizon and this comparison isn't even close. AT&T looks like a much better choice for the following reasons:
This model is conservative for multiple reasons. First, I've only assumed 2% cash flow growth. AT&T should be able to easily achieve that with inflation (i.e. price increases) and synergies achieved with the Time Warner Acquisition. For comparison, AT&T's long-term growth rate is 5.9% according to Reuters. Second, I've assumed a much higher beta (AT&T's actual beta is approximately 0.7x), which increases the required rate of return.
Wall Street is mixed on AT&T, but the overall consensus expectation still shows upside, which is consistent with my analysis. According to MarketWatch, the average target price is $34.24, which represents 12% upside based on the current share price of $30.66.
There are a few risks worth pointing out. First, there's no guaranty that the integration of Time Warner continues to go as planned. There's always the risk that AT&T paid too much and synergies are never realized. The second major risk I see is AT&T's balance sheet. The Time Warner deal has increased AT&T's debt level to $183 billion and created a serious leverage issue. To put that in perspective, that's more debt than AT&T produces in annual revenue. However, the early indications of the Time Warner deal are positive. According to AT&T's last earnings release, all of WarnerMedia's units continued to show growth and AT&T's CEO had the following comments:
Our U.S. wireless business is growing and it’s the single biggest contributor to our earnings and cash flow. WarnerMedia was immediately accretive in its first full quarter, contributing 5 cents to EPS, and our free cash flow grew by double digits."
I also see AT&T's debt level as manageable. If you refer back to my dividend analysis, there's historically been leftover free cash flow, which can be used to pay down debt. The company has also consistently made a point to work leverage multiples down. As a last resort option, AT&T could also cut its dividend if needed. With those issues being understood, I still believe the risk/reward proposition is compelling. The stock trades at significant discounts according to my cash flow model, historical valuation multiples, and a comparables analysis. On top of that, the dividend yield of more than 6% will significantly increase compounded returns over time. The bottom line here is that there's significant upside if AT&T executes on its expectations.
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