In this article, we're taking a look at AT&T (NYSE:T) from the viewpoint of an income-seeking investor. We're also comparing it to Frontier Communications (NASDAQ:FTR). Although Frontier has a market cap of just $7 billion (versus AT&T's $180 billion), we think the two could make for an interesting comparison. That's because they have both been viewed as potentially attractive income plays in recent months as a result of their relatively high dividend yields. The two companies also sit in the same GICS sector of telecommunications services, as well as the same GICS sub-industry of integrated telecommunications services. We're aware that many investors apportion their capital based on GICS sectors and GICS sub-industries, so we feel a comparison is worthwhile and useful.
As alluded to, AT&T has proven to be a relatively popular income play in recent months. That's mainly because the company has a forward yield of 5.2%. Rewind ten years, and a 5.2% forward yield may not have been all that impressive, but with today's level of interest rates, it is a stunning yield. Indeed, the S&P 500 yields just 1.9%, which makes AT&T's yield 2.7 times that of the wider index. If you were deciding whether to buy AT&T as an income play based solely on its yield, it would be a strong buy.
Another strong buy would be Frontier. That's because it yields even more than AT&T, with its forward yield being a simply stunning 6.1%. That blows most of its US peers out of the water -- few stocks can match or beat that yield.
However, we think there's much more to income investing than which stock has the highest yield. Taking a closer look at the sustainability of dividends (as well as the potential for dividend per share growth) can prove to be even more important than the initial yield.
On the face of it, AT&T's payout ratio indicates that its dividends are highly sustainable and that there is considerable room for them to grow. For example, its payout ratio currently stands at a mere 54%. However, that figure doesn't take into account the drop in earnings that are forecast for the current year (EPS is set to fall by 24.2% year-on-year), which means that AT&T's payout ratio is actually 71%.
Sure, there is still room for it to tick a little higher. But there is far less room than there was at a payout ratio of 54%. This means that unless AT&T can grow its bottom line, dividend per share growth could be limited moving forward (more later on earnings growth potential).
Meanwhile, Frontier's payout ratio stands at a whopping 400%! However, as with AT&T, that's based on last year's numbers. Using this year's forecast EPS (which is expected to double year-on-year) means that Frontier's payout ratio is more like 200%, which is still exceptionally high and of cause for major concern.
Reading Frontier's recent results, though, the company provides a payout ratio figure of 46%. Its figure utilizes free cash flow rather than net profit, which explains the huge difference in the two figures. As with AT&T, it appears as though improvements in profitability and cash flow could be key to future increases in dividends per share.
Although EPS is set to fall by 24.2% at AT&T this year, next year looks a whole lot better. The company's bottom line is due to increase by 4.6% next year, which shows that there could be scope to increase dividends moving forward. Sure, 4.6% may not sound like a particularly strong growth rate, but it is roughly in line with the wider market, and if most of the gains are passed on to shareholders in the form of higher dividends, it should provide an increase in dividends in real terms.
Unlike AT&T, though, Frontier is forecast to see its bottom line fall by 5% next year (after doubling in the previous year). This leaves it with a sky-high payout ratio based on net profit, but with the company's cash flow appearing to be in good shape, the real-terms value of Frontier's dividend should at least be maintained.
When it comes to valuation, we think that AT&T is highly appealing. Its forward P/E ratio is very attractive, with it being just 12.8. This is 23.8% lower than the S&P 500's forward P/E, and shows that there is considerable scope for an upwards adjustment to the company's rating. Furthermore, AT&T has an EV/EBITDA ratio of just 5.5, as well as a 5-year price to earnings growth (PEG) ratio of 2.69. Sure, there are many companies with lower PEGs, but for a stock that yields 5.2%, we think that this is actually quite appealing.
Meanwhile, Frontier's forward P/E ratio is extremely high at 35.6, owing to the company's relatively low and volatile bottom line. A more relevant valuation metric, however, could be the price-to-cash flow ratio (due to the company's preference to use cash flow rather than profit when calculating the payout ratio), which comes out at just 4.6. This is significantly below that of the S&P 500 (which has a price-to-cash flow ratio of 11.1), and is even lower than AT&T's of 5.4. Clearly, both stocks offer potential upside, as well as great forward yields.
We're bullish on AT&T from an income-seeking perspective. We consider it to be a core income play due to its top-notch forward yield, potential for a small increase in the payout ratio, as well as its low and attractive valuation (on an absolute as well as relative basis).
Frontier is also a stock that we think has huge appeal as an income play, but with profitability being volatile and rather low, we think that AT&T is the steadier income play right now. Sure, Frontier's free cash flow remains strong and both companies have attractive price-to-cash flow ratios. However, while both stocks are great income plays, we think that AT&T is the hotter ticket right now.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.