AT&T (NYSE:T) is operating in a challenging (and changing) business environment but I believe that there is a lot to like about how this company is positioned for 2018 and beyond. In "AT&T: I Like Where You Are Heading", I described to the Seeking Alpha community why I was bullish about AT&T's future growth prospects. However, the company's stock performance since that point in time has been nothing to write home about.
The graph above does not tell the whole story (i.e., the stock performance does not include dividends) so, in my opinion, the past underperformance is not a good reason to jump ship just yet. This telecom company has several catalysts in place that should help propel the stock price higher and allow for AT&T to be a market beater over the next three years so, in my opinion, it will be different this time around.
Before we get to the real reason why shareholders are invested in AT&T (i.e., the dividend), let's focus on the catalysts that I believe will help the company's stock performance beat the market over the next three years:
To start, I believe that AT&T has an international business that has great long-term business prospects. It also helps the bull case that the company has already shown the ability to grow its businesses outside of the U.S.
Plus, there are now rumors that AT&T may soon enter the Brazil mobile market and, while I believe it is a little premature to get too excited, as a long-term shareholder I am encouraged about this potential market opportunity.
Connect This, Connect That
The global economy is entering into a period of time where almost everything around us is becoming connected. Connected devices are now the new normal, and the companies that are key players in this industry are in a position to benefit from the connectedness. To think about this potential market opportunity, let's consider three Internet Of Things ("IoT") projections:
These estimates are all over the place but there is, however, one common theme - that is, the connected device market is expected to experience significant growth in the years ahead. I believe that AT&T will be a big winner in this 'new' landscape and, in my opinion, this has not yet been priced into the stock.
AT&T's promising 5G prospects have already been well-covered here on SA (see this article) so I do not want to spend a lot of time on the topic, but, in my mind, 5G will be a key growth driver for this company for at least the next few decades.
On one hand, I believe that AT&T will be a winner with or without the Time Warner (TWX) but, on the other hand, I do believe that the proposed merger will add value to AT&T's business mix and could actually be the catalyst that pushes T shares back above the $40 threshold in early 2018. Yes, the tie-up will better position AT&T in the changing pay-TV space but the merger definitely comes with risks that need to be considered (integration risk, rising debt balance, etc). To be clear, I am bullish on proposed merger but I believe that AT&T will be a great long-term investment with or without the Time Warner assets, of course in my opinion.
No one should be surprised by the fact that the market views this mature, well-established telecom company as an income play, but, again, it should be noted that this company has more going for it than just a healthy dividend. To this point, AT&T reported strong adjusted earnings growth for full-year 2017.
The top-line number is nothing to brag about but I am not overly concerned given the backdrop (i.e., price wars, wireline declines, DirecTV subscribers). Moreover, I believe that the subscriber number concerns are overshadowing what is expected to be a strong 2018.
Management guided for impressive adjusted EPS growth in addition to improving cash flow metrics for the next four quarters, so investors should be excited about what 2018 may bring for AT&T.
Now, let's get to the real reason why most people are invested in this company.
The Dividend - Is It Sustainable?
AT&T pays an above-average dividend.
The sustainability of the company's dividend was a risk that the bears used to bring up, but I feel that management was able to fully put those concerns to bed in 2017. The company's free cash flow ("FCF") and financial leverage are two metrics that are mentioned the most when discussing AT&T's dividend prospects.
It is encouraging that the company improved its FCF dividend payout ratio by 130 bps over the last 12 months.
Source: AT&T's Supplemental Document for Q4 2017
More importantly, the company's FCF has been trending in the right direction over the last few years.
Additionally, as shown above, management expects for AT&T to have a strong fiscal 2018, which includes a FCF number well-above the prior year's figure ($21B vs $17.6B).
AT&T's leverage is a different story because, as many are already aware of, the company's debt balance has grown substantially over the past few years.
The company's financial situation is not as dire as you might think but, in my opinion, management will need to get a handle on AT&T's [growing] debt balance in 2018 and 2019. However, as I previously described in "Is AT&T Taking On Too Much Debt?", AT&T's debt balance is a concern but not a game-changer, at least yet.
At the end of the day, I believe that AT&T's rich dividend is definitely sustainable and that the company's dividend growth prospects are actually improving by the day. So, coupled with the fact that the company's fundamentals are improving, I believe that there is a lot to like about AT&T at today's valuation.
AT&T's stock is trading at an attractive valuation when compared to its closest competitor, Verizon (VZ).
Let's also not forget that AT&T is trading well-below the market's multiple.
The Time Warner merger gets all of the attention, and rightfully so, but I see a lot of value in T shares at today's price. AT&T has struggled to grow its top-line but the company's earnings growth story is something to talk about. The foreign investments, connectedness of the economy, and the company's 5G push all have the potential to be significant growth drivers for AT&T over the next few years. Plus, you are getting paid a healthy (and sustainable) dividend while you wait for the company's story to play out.
Therefore, I believe that investors should stay long AT&T's stock because, as I previously described here, the management team continues to improve the company's business prospects. As such, investors should treat any significant pullbacks as long-term buying opportunities.
Author's Note: All images were taken from AT&T's Q4 2017 Earnings Presentation, unless otherwise noted.
Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
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Disclosure: I am/we are long T, TWX. 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.