By Mark Bern, CPA CFA
AT&T (T) is the second largest wireless carrier (behind Verizon (VZ)) in the U.S. The company pays a dividend of $1.72 per share which equates to a six percent yield. That dividend requires about $10.2 billion be paid out this year. How well does the company have that dividend covered?
- The payout ratio is 87 percent.
- The debt-to-equity ratio is coming down and is currently near 50 percent.
- Cash on hand is over $10.5 billion.
- Annual leveraged free cash flow amounts to about $8.3 billion over the last 12 months.
- Cash flow is expected to grow at about 3.5 percent per year over the next few years.
- Dividend increases are expected to be in the two to three percent range going forward.
I would say that the company should be able to cover a rising dividend for several more years based upon those data points.
The pending acquisition of T-Mobile (OTCQX:DTEGY) may alter the equation somewhat, but I think there is still room to continue AT&T’s record of 26 consecutive annual increases. Speaking of T-Mobile, I suspect that the merger/acquisition will proceed, but will require some concessions by AT&T in some geographic areas. But the price of those concessions should not deter AT&T from completing the deal because of the cost the company would absorb if it fails: the break-up fees could exceed $6 billion. Wouldn’t you aggressively contest the Justice Department’s case in court?
Actually, I expect the parties to negotiate a settlement as that is the course most often taken by government. The concessions will probably be in the form of some network access and wireless spectrum in areas that are deemed to otherwise lack adequate competition after the merger. But AT&T will come out ahead in the end by expanding its network and being able to offer better coverage to both customers and partners (primarily Apple (AAPL) and Google (GOOG)).
Revenue growth, with or without the acquisition, should come in around 8 percent per year. With dividends increasing in the range of two to three percent per year, the payout ratio will come down to a more reasonable level in just a few years.
Now why do I think of AT&T as a defensive stock?
- The company will still be here when our grandchildren are deceased. It has staying power proven since its break up in 1984 and all the way back to its roots during the 1800s.
- The dividend will act as a life preserver in bad times to prevent the stock from falling as much as the overall market indices do.
- The price got down as low as $21.44 in March 2009. The stock reached its high of $42.97 in September 2007. That was about a 50 percent drop from a level that was overvalued. The S&P 500 index dropped by about 57 percent from high to low over a similar period. I suspect that T was more overvalued than the index in 2007, but the company is not overvalued at present. I think AT&T will fare far better relative to the S&P 500 if the market were to crash any time soon.
- And, of course, how many people are going to disconnect those cell phones? More folks are disconnecting wire-line connections and will continue to do so in favor of wireless convenience.
- The company has also been adding new customers to the tune of over 300,000 per quarter and that pace is likely to increase during the 4th quarter due to increasing sales of the iPhone 4S stemming from the pent up demand that built during the third quarter while prospective customers put off buying a new phone until Apple introduced the new version.
- AT&T’s U-Verse, a digital video service, represents a potential new driver of increased revenue for years to come.
Finally, I just can’t ignore the increased revenue per subscriber that comes from upgrading from traditional phones to the new smartphones. Having gone through the process myself recently with my family, we are now paying about 40 percent more each and every month. And we will never go back! The additional service is definitely worth the extra cost. The U-Verse service also portends increased revenue per wired customer as well. Even in a recession, more than half the households in the country continue apace while the other half suffers most of the economic brunt. For AT&T that translates into slower growth or possibly a minor shortfall in revenues. In 2009, sales per share dropped from $21.05 to $20.84 and then rose again back up to $21.05 in 2010. That is the definition of a defensive stock: a company that can take economic collapse in stride.