AT&T (NYSE:T) is a solid company with excellent prospects for organic growth. Couple this with the fact the company pays a hefty dividend yield of 5.33% and you have an excellent buying opportunity for savvy dividend investors. The company has strong cash flow and is focused on returning capital to shareholders through buybacks as well. In the following sections I will lay out my bull case for the stock.
Dividend investors can expect capital appreciation based on organic growth
AT&T is well positioned for organic growth going forward. Several positive drivers pushed first quarter adjusted EPS of $0.71 up nearly 11 percent year over year.
(Chart provided by ATT.com)
Revenue growth rose 3.6 percent marking its most robust uptick in over two years. The consolidated operating income margin is expanding due to improving wireless margins. AT&T's Project VIP was a huge contributor to growth in revenues.
(Chart provided by ATT.com)
Consumer revenue grew 4.3% overall with total U-verse revenues up 29 percent. U-verse subscribers passed 11 million with 634,000 U-verse high speed broadband subscribers added in the quarter. This was the best performance in four quarters. I submit as Project VIP continues to expand AT&T's addressable footprint improved revenues and margins will follow. These continued efforts should drive the stock price higher, giving patient dividend investors an opportunity for capital appreciation as well as potential dividend increases.
The company is undervalued on a historical and relative basis
AT&T is a solid company with excellent prospects for future growth. Even so, I posit the stock is underappreciated currently. The stock is trading at a TTM P/E ratio of 10 is among the lowest of any stock in the industry, and signals that investors have not been willing to pay a premium for this company's business prospects.
(Table provided by Scottrade.com)
AT&T trades for a P/E of 10.2, while the industry average is 20.8. This implies AT&T has significant upside simply to trade on par with the company's peers. I feel the upside in the stock is not priced in currently.
(Table provided by Yahoo.com)
Strong free cash flow provides opportunity for increased return of capital to shareholders
Cash flow from operations was $8.8 billion. Free cash flow was 3 billion after backing out capital expenditures of $5.8 billion.
(Table provided by ATT.com)
This strong free cash flow allowed the company to buy back 37 million shares in the quarter for $1.2 billion. Cash flow is an extremely important factor in determining the value of a stock. I posit investors are currently taking this for granted as many have been focused on growth and momentum stocks. Nonetheless, there seems to be a shift in market sentiment recently. I believe a shift in focus to more conservative low beta stocks such as AT&T's will drive the stock higher.
AT&T's downside risks are many. First, the competitive environment for the company is vicious. A relentless onslaught of new products and competitors attempt to disrupt the status quo on a daily basis. Furthermore, macroeconomic and geopolitical risks which are out of the company's control could take a turn for the worse at any time.
AT&T has a solid long-term growth story and pays a hefty dividend of 5.3%. Furthermore, AT&T is a dividend-paying stock with the potential for both capital gains and income production. Based on the current facts available, I posit AT&T should be trading for at least a P/E of 12.5 by 2015. This implies the stock has 25% upside and a $45 price target. Moreover, AT&T is a better hedge against inflation than fixed income instruments such as bonds and CDs. AT&T's 5.3% dividend yield and the company's opportunity for growth provide the framework for outstanding returns. Nevertheless, if you choose to start a position in any stock, I suggest layering in a quarter at a time at a minimum to reduce risk.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in T over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.