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The telecom sector has some of the most stable companies due to the massive size and stable growth in revenues and cash flows. Adding telecom stocks to a portfolio can bring stability as well as gradual growth both in terms of dividends and capital gains. This minimizes the risk of the overall portfolio. However, it should be kept in mind that the growth rates are relatively low in this industry. AT&T (NYSE:T) is one of the biggest and best-placed companies in this sector. Over the course of 2013, the price of the stock remained roughly the same. However, the real attraction is the dividend yield of 5.5%, which has been growing impressively as the company has been increasing its dividends.

A Glance at the Earnings and Competition

AT&T recently announced its fourth quarterly earnings according to which, diluted EPS grew from $(0.68) to $1.31 in the fourth quarter. However, excluding significant items, the EPS was $0.53 compared to $0.44 during the same quarter last year. Significant items are usually one-time charge-offs or extraordinary income, both of these items should be ignored in order to gauge the performance of the core business of the company. In case of AT&T, the growth in core earnings was 20.5% year-over-year.

AT&T continues its war against T-Mobile (NYSE:TMUS) by offering $100 for each line the company adds in its service. In order to get the credit, the customers must keep the service for 45 days in good standing. Further, it will be divided into three billing cycles. This promotion is the latest in the fight between T-Mobile and AT&T - both of these companies have been fighting for quite some time now. While offering such promotions certainly brings some new customers; I have never been a fan of the price competition - in the end, the business suffers and the only winner in these battles is the customer. Since we are focused on the business and whether it is a good investment or not, competitions such as this can only be categorized as a negative. Price competitions result in deterioration in margins most of the times, and as I mentioned above, the industry already has slim margins. In response to this move, T-Mobile offered to pay the early termination charges on behalf of its customers for leaving AT&T, Verizon (NYSE:VZ) and Sprint (NYSE:S) and signing up for its service.

New Patents to Increase Efficiency

It was recently revealed that AT&T has applied for a patent which may increase its efficiency. This patent would restrict the excessive use of bandwidth which, in the patent, is called non-permissible. In simple words, what it will do is, segregate the bandwidth levels to specific types of customers and charge them accordingly. Previously, if a user was to download a large file, other users would have had to wait for the bandwidth to be free, creating a lag in the service and wastage of bandwidth. With this patent, the company can charge a penalty for non-permissive use of bandwidth. This would not only increase the efficiency and quality of service, but would also allow the company to gain in the form of penalty charges for the people who use the excessive bandwidth. Later, they can offer a separate block of service for people who need larger bandwidth and extract more revenue by charging more.

Dividends and Free Cash Flows: Sustainable?

Whenever we talk about a high-yielding stock, there is always the question of sustainability of dividends. We can test the company for sustainability of dividends through different measures - my favorite is the payout ratio based on free cash flows and the future expected growth in the free cash flows of the company. Let's analyze the free cash flows and payout ratio based on free cash flows over the past twelve months. For me, a company should have around 40% in buffer in order to continue growth in its dividends - however, this is not a rule, a company with over 60% payout ratio can easily maintain its revenue growth if the growth in the cash flows is enough to support the dividend growth as well as capital expenditures.

Over the past twelve months, AT&T has paid $9.8 billion in cash dividends. At the same time, the company has repurchased common shares worth $15.5 billion. So, in total, AT&T has returned over $25 billion to its shareholders in the last twelve months. However, during the same time, the company has issued over $14 billion in new debt and repaid about $4 billion worth of its debt. As a result, net increase in the total debt of the company comes close to $10 billion. Most of the stock repurchase has been financed by new debt, and it looks like the company is increasing leverage.

However, despite the increase in its leverage, the company has been able to generate impressive cash flows. Capital expenditures during the past twelve months have been close to $21.5 billion. Despite massive capital budget, the company was able to generate close to $16 billion in free cash flows, which puts its dividend payout ratio at around 61%. The strength of the company's cash flows is apparent from these figures. There is still a substantial buffer available to the company, and I believe it will continue to grow its dividends.

Conclusion

AT&T is one of the most stable companies in the telecom sector - the company has been growing at an impressive rate and it generates massive cash flows. AT&T has been increasing its dividends annually by 2% since 2008. As I mentioned above, the margins are slim in the industry and the company should avoid price competitions, instead, it should try to compete on the quality of its services. The growth in revenue and cash flows is impressive, and a healthy buffer in cash flows should allow the company to continue growing its dividends and fund its expansion plans.

Source: AT&T: One Of The Best Dividend Picks?