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AT&T (NYSE:T), formerly known as SBC Communications, Inc., has been a consistent dividend stock for the past 25 years. SBC Communications acquired AT&T Corp. in 2005 and assumed its ticker symbol of T and changed its name to AT&T, Inc., hence data prior to 2005 presented in this article is actually that of SBC.

T had about $124.3 billion in revenue and $19.9 billion in net income in 2010. T has a market capitalization of $169.0 billion and an enterprise value of $231.8 billion, suggesting significant leverage. T has a strong track record of paying dividends. For 2010, its payout ratio to net income was 50% and its payout to operating cash flow was just 28%. However, when removing capital expenditures from operative cash flow, this payout ratio would be 64%. T has significant capital expenditure requirements that reduce free cash flow.

T's estimated forward dividend yield is 6.1% based upon a closing price of $28.52 and the author's projected annual dividend of $1.75. The following table shows the estimated forward quarterly dividends as well as the recent historical quarterly dividends with a recent growth rate around 2%, down from earlier double digit growth rates.

Historical and Projected Dividends
Type Ex-Dividend Date Quarterly Dividend ($ per share) Change on prior year
Projected 7/6/2012 0.440 2.3%
Projected 4/6/2012 0.440 2.3%
Projected 1/6/2012 0.440 2.3%
Projected 10/6/2011 0.430 2.4%
Historical 7/6/2011 0.430 2.4%
Historical 4/6/2011 0.430 2.4%
Historical 1/6/2011 0.430 2.4%
Historical 10/6/2010 0.420 2.4%
Historical 7/7/2010 0.420 2.4%
Historical 4/7/2010 0.420 2.4%
Historical 1/6/2010 0.420 2.4%
Historical 10/7/2009 0.410 2.5%
Historical 7/8/2009 0.410 2.5%
Historical 4/7/2009 0.410 2.5%
Historical 1/7/2009 0.410 2.5%
Historical 10/8/2008 0.400 12.7%
Historical 7/8/2008 0.400 12.7%
Historical 4/8/2008 0.400 12.7%
Historical 1/8/2008 0.400 12.7%
Historical 10/5/2007 0.355 6.6%
Historical 7/6/2007 0.355 6.6%
Historical 4/5/2007 0.355 6.6%
Historical 1/8/2007 0.355 6.6%

Source: Author estimates, Yahoo Finance

The following graph shows the historical trailing twelve month yield and spread to the 10-year Treasury bond.

Created from data from Yahoo Finance

The next graph shows the normalized performance of the stock price, the dividend, and the trailing dividend yield.

Created from data from Yahoo Finance

The above chart shows that T has significantly underperformed its dividend increases, suggesting that either it is undervalued or that T's growth prospects have diminished.

Dividend Discount Model suggests T is undervalued

The first step to using the dividend discount model is to calculate an equity hurdle rate with the Capital Asset Pricing Model. T has a beta of .44 and with the risk free rate at a very low 1.9% this gives the discount rate to be a 5.0%. As noted above the forward dividend is approximately $1.75. Applying a long term growth rate of 1% gives an estimated price of $43.75 for T. However, as with any dividend discount model, the result is highly sensitive to the growth rate and equity hurdle rate assumptions. As interest rates climb again this value will fall. Furthermore, even 1% growth may overstate T's long term growth rate. The following table shows some sensitivities that clearly illustrate that high interest rates would bring T's value closer to the current market value.

Dividend Discount Model Sensitivities
Sensitivity Equity Hurdle Rate
Growth Rate 4.0% 5.0% 6.0% 7.0%
-2.0% 29.17 25.00 21.88 19.44
-1.0% 35.00 29.17 25.00 21.88
0.0% 43.75 35.00 29.17 25.00
1.0% 58.33 43.75 35.00 29.17
2.0% 87.50 58.33 43.75 35.00
3.0% 175.00 87.50 58.33 43.75

Source: Author calculations

T appears to offer a good dividend with potential upside appreciation. Yahoo!Finance estimates its 2012 P/E ratio at 11.2x which might make some investors cautious given its recent low dividend rate. However, this type of analysis is primarily focused on income statement metrics and not on cash flow. T could probably improve its growth rate by increasing payout ratios without creating too much additional risk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.