High-dividend yields may be good opportunities or dividend traps because generally a dividend yield which is considerably above-average is a warning sign for income investors. Therefore, it is extremely important to analyze the company's fundamentals to see if there exists undervaluation, reflected on the unusually high-dividend yield, or the dividend cut risk is the reason why the dividend yield is so high. AT&T (T) is one of the few exceptions in the marketplace, offering a high-dividend yield that is clearly safe considering the company's strong business fundamentals as I discuss in this article.
AT&T Inc., headquartered in Dallas, Texas, is the largest provider of integrated telecommunications in the United States. The company formerly known as SBC Communications (originally Southwestern Bell Corp.) was created following the break-up of the original AT&T Corp. in 1984. Through a series of mergers, the company has put parts of the original AT&T back together to form the new AT&T Inc., which offers local voice, video and Internet, long-distance, and wireless services. AT&T has more than 109 million customers which ranks it second behind Verizon (VZ) in the U.S. The company is listed on the New York Stock Exchange and has a market capitalization of $184 billion.
Its wireless division its the company's largest accounting for about 54% of revenues, with the remaining being generated by its wireline division. AT&T competes with all major domestic providers of wireless communication services. Its primary competitors are Verizon, Sprint (S), and T-Mobile (TMUS), but it also faces competition from regional carriers and other providers of voice, video, and data transport services. AT&T has ongoing a three year investment program of $14 billion to upgrade its networks, which should strengthen its position and allow it to gain market share from its competitors. In 2012, AT&T generated more than $126 billion in revenues and its EBITDA stood at $41.4 billion, or an EBITDA margin of 32.5%. Its net income was above $7.2 billion, or $1.25 per share.
Where Is The Growth?
AT&T has struggled to grow over the past few years amid competition from its three major competitors. In 2012, its revenues amounted to $126 billion representing an increase of only 2.4% from the previous year. During the first nine months of 2013, AT&T's operating revenues were $95.6 billion, up by only 0.8% compared to the same period in 2012. Given AT&T's huge size and the high mobile penetration rate in the U.S., AT&T should continue to post relatively small growth over the next few years. The company's $14 billion investment program that goes from 2013 to 2015 to upgrade its networks should help abate the revenue declines in wireline, sustain wireless growth, and improve profitability over time. However, it does not seem enough to be a game changer as, according to analysts' estimates, AT&T's revenues should increase 2.4% in 2014 and by only 1.2% in 2015. Compared to Verizon, this performance is relatively weak given that Verizon is expected to increase revenues by 3.8% in 2014 and 3% in 2015. Moreover, Sprint and T-Mobile completed transactions in 2013 to improve their ability to compete with AT&T and Verizon, so industry competition should remain fierce being a negative risk for AT&T's growth over the next couple of years.
Therefore, it is not surprising that AT&T has made public over the past few months its intentions to grow abroad through acquisitions, targeting specifically Europe. According to media sources, the company has explored potential deals with Telefonica (TEF) and Vodafone (VOD) but so far without success. Moreover, the likelihood of a major purchase in Europe is quite low due to political opposition, as seen in its approach to Telefonica. Furthermore, as most European markets are already saturated markets and the European economy has been quite weak over the past few years Europe may not be the best option for AT&T to search for growth.
As I discussed in my previous article, AT&T should forget Europe because a better alternative may be available in TIM Participacoes (TSU), the Brazilian unit of Telecom Italia (TI). TIM Brasil is currently the second-largest Brazilian mobile operator, with more than 72 million customers. The company provides telecommunications services with a nationwide presence in Brazil. TIM Brazil would give AT&T improved growth prospects and an increase of its profitability, without leading to much higher balance sheet leverage depending on how much new debt it decides to issue finance this potential acquisition.
AT&T has an impressive dividend history given that it has increased its dividend consecutively for the past thirty years, being therefore a 'dividend aristocrat'. Its last dividend increase was announced in past December, increasing its quarterly dividend by 2.2% to $0.46 per share or $1.84 per share on an annualized basis. The next dividend will be payable on February 3, 2014, for shareholders of record on 10 January, 2014. At its current stock price, AT&T has an attractive dividend yield of 5.2% being among the highest in its industry and above its closest peer Verizon. Moreover, it is the second-highest yielder among the S&P 500 dividend aristocrats behind HCP (HCP), offering therefore a both a long history of dividend payments and a very good income stream. Its dividend payout ratio is 75% taking into account its trailing twelve months earnings, which is acceptable for a mature and stable company like AT&T.
In addition to returning cash to shareholders through dividends, AT&T has been a big buyer of its own stock over the past couple of years. Since the beginning of 2012, the company has repurchased about 684 million share or roughly 11% of its shares outstanding at the end of 2011. This has increased total shareholder remuneration by more than $40 billion since beginning of 2012, which is a huge amount even for a blue chip company. In 2013, AT&T has returned $18.5 billion to shareholders through dividends and share buybacks.
AT&T is a cash cow given its very strong cash flow generation capacity. During the first nine months of 2013, AT&T's cash flow from operating activities was $26.9 billion, which is way above its capital expenditures of $15.8 billion. Its resulting free cash flow of $11.1 billion is above the company's dividend payments, which amounted to $7.3 billion during this period, showing that is dividend is clearly safe from a cash flow perspective. However, as AT&T's total shareholder remuneration policy is very aggressive given that it has returned about $18.5 billion during the nine months to shareholders through share buybacks and dividends, implying some financing through additional debt increasing the company's balance sheet leverage.
At the end of the third quarter of 2013, AT&T's net debt was about $75 billion. Its net-debt-to-EBITDA ratio was 1.76x, which is acceptable for a stable company like AT&T and could be even slightly higher without jeopardizing its shareholder remuneration policy. Moreover, its leverage is expected to remain stable over the next few quarters because AT&T has recently sold and lease towers to Crown Castle for almost $5 billion and will sell its wireline operations in Connecticut to Frontier Communications (FTR) for $2 billion. Both deals will generate cash inflows that support its shareholder remuneration policy without having a material impact on its profitability and growth outlook.
AT&T offers an unusually safe high-dividend yield supported by its stable and profitable business, impressive track record, strong cash flow generation and balance sheet. Its weakest point is fierce competition domestically that hampers its growth prospects, which could be offset by internationalization but AT&T is struggling to buy assets abroad. Regarding its valuation, AT&T seems to be fairly valued trading at 14.1x estimated earnings, which is slightly higher than its ten-year historical forward P/E of 13.6x but is much cheaper than Verizon that is trading at 17.5x forward earnings. Due to lower expected growth at AT&T, a discount is warranted but its spread to Verizon is quite wide and should tighten over the next few months. Therefore, AT&T seems to be a good choice for income investors given its attractive valuation and leading dividend yield, providing investors a compelling income investment proposition over the long-term.