AT&T: Addressing A Current Income Requirement

| About: AT&T Inc. (T)

Summary

AT&T has been a very solid income generator over the years.

This article looks at some possibilities to address a current income requirement.

In the end it's about being aware of the flexible alternatives available to you.

There have likely been better times to think about partnering with AT&T (NYSE:T). With shares trading hands around $41, that equates to a starting earnings multiple near 14 and a beginning dividend yield of about 4.8%. To be sure those might look comparatively attractive, but when you look back at AT&T's history since the recession, a multiple in the 11 to 13 range with a dividend yield north of 5% has been more typical.

Of course I am reminded that just because shares may not be offering a great deal, this does not simultaneously indicate that a poor one is now being offered. You still have a very successful business pumping out north of $15 billion in profits. The dividend is well above average and grows a small amount each year. And you can even make a case that the company's growth prospects are now a bit better as well.

With these things in mind, it makes sense why investors - especially income investors - still look to the name to fulfill their investing goals. There's something to be said for an above average cash flow stream.

What I'd like to consider today is someone that has a "current" or upfront cash flow need in conjunction with an ongoing one. AT&T has been and will likely continue to be solid on the ongoing front over time. With the 4.8% starting yield, that equates to 1.2% every quarter. Yet it's conceivable that someone has a need or desire for generating that cash today or tomorrow instead of in a year or two.

Say there's an unanticipated expense or someone would simply like to glide into retirement with a bit larger starting cash safety net. Whatever the situation happens to be, it can useful to know your options. In this case literally.

One thing that is available to you are call options. I'm going to demonstrate this in "just" 100 share lots, but naturally you can think about it in much higher multiples to fit your own situation.

As I write this the share price of AT&T sits just above $41 and the $42 strike for the January 2018 expiration date has a bid of $2.00 - call it $1.90 after fees. That means that if you agreed to sell your shares at a price of $42 anytime between now and January of next year you would receive ~$190 upfront - or a 4.6% starting yield - effectively mirroring the dividend cash flow component on day one.

Now one of two things happens with this agreement: either it is exercised or it is not.

If the option is not exercised, you have fulfilled both your current and ongoing cash flow needs for the year. You keep the 4.6% upfront option premium (which can be taxed differently than dividends) and you'd also go on to receive dividend payments along the way. For the year your cash flow might equate to ~9.5% or so of today's starting point.

Now some will point out that this does not prevent you from seeing a loss, which is true. Yet two important notes should be made: 1) the main goal of increasing your cash flow was achieved and 2) if the option is not exercised this is always going to be a superior result as compared to simply buying and holding.

There's no telling if you could repeat this next year, but for the moment you have easily increased your cash flow.

The second basic possibility is that the share price goes above $42 and you're forced to sell your stake. In this case you would still have your 4.6% upfront option premium. In addition, you may also receive dividend payments along the way, depending on the timing of the option being exercised.

Your sale proceeds would be ~$4,200 (less fees) for every 100 shares owned. The return based on today's price would be ~7% to ~12% depending on how many dividend payments are collected along the way. This isn't a spectacular return, but it is solid and would at least fulfill the upfront cash flow requirement.

The risk is twofold. There's an opportunity cost that shares might later trade at say $45 or $50 and you'd be "stuck" selling at $42. That's a real risk and ought to be considered beforehand. The second thing to think about is that you would generate a solid gain, but now you'd have capital to allocate once more. These funds, now a year later, may or may not be able to be redeployed intelligently to meet your goals.

We can go the other way as well. As I write this the $40 put option for AT&T on the same January 2018 expiration has a bid of $3.10 - call it $3.00. So if instead of already owning shares you're looking to invest, this might be a possibility.

You would be agreeing to buy at least 100 shares at a price of $40 - roughly a 2.5% lower price than what is offered today - anytime in the next year. For making this agreement you would receive ~$300 upfront, or a 7.5% upfront cash flow stream based on the capital set aside.

Once again, one of two basic things occur: either the option is exercised or it is not.

If the option is not exercised you keep the 7.5% starting cash flow (which you can immediately use for whatever you'd like) and the $4,000 per 100 shares would then be "released" and available to be redeployed once more.

The risk here is that shares might go to $50 and you'd be "stuck" with "just" a 7.5% gain. Moreover, there's no guarantee that you could do something similar next year. Still, if you have an upfront cash flow need - generating 7.5% today for a year's agreement isn't the worst of situations.

If the option is exercised you still have the 7.5% starting yield that you can use however you'd like. In addition, you would also own 100 shares of AT&T that by that time might be poised to offer a 5% starting yield. If you're happy to own shares and collect the dividends, this would be a fine result - not only did you fulfill your starting income requirement, you also bought shares at a lower cost. Further, once you owned shares you could again think about future call options to continue boosting your income from there.

Now it should be underscored that I'm not recommending this strategy. Yet I believe it's helpful to learn about nonetheless. If you have an upfront and ongoing cash flow requirement, these are the sorts of things that you can consider. Naturally there are some potential downsides as well, but the point is that there are flexible alternatives out there to help you work toward your investing goals.

Disclosure: I am/we are long T.

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.

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