Income investors typically have to make a trade-off between dividend yield and dividend growth. But AT&T is a notable exception.
Not only does AT&T have a high yield of 5.3%, it has also increased its dividend each year for over 30 years in a row.
AT&T's recent earnings showed it is making progress in deleveraging and incorporating its massive Time Warner acquisition.
With a mix of growth and yield, AT&T is one of our favorite Dividend Aristocrats right now.
By Bob Ciura
Companies that raise their dividends for long periods of time are often the most revered amongst income investors. And that makes sense as these companies have managed to increase their dividends through all portions of the economic cycle.
Companies with at least 25 years of dividend growth are especially attractive investments for several reasons. For one, there are only 57 such companies, known as the Dividend Aristocrats.
One company that remains a favorite among dividend growth investors is AT&T Inc. (T), which offers a 5%+ yield at the moment. Reviewing the company, we find that investors should like much more than just AT&T’s high dividend yield.
Quarterly Earnings Overview
AT&T has been in business since the late 1870s and can trace its existence back to Alexander Graham Bell and the first version of the telephone. The company investors know today came about as a result of multiple mergers and spinoffs that have taken place since the 1980s.
While many know the company for its phone business, AT&T has taken steps to diversify its revenue streams in recent years. The company purchased DirecTV in 2015. AT&T then bought Time Warner in 2018. Inclusive of debt, AT&T paid $85 billion for these assets.
Shares of AT&T trade with a market capitalization of $279 billion and the company generated $170 billion of revenue last year.
AT&T reported third-quarter earnings results on 10/28/2019.
Source: AT&T’s Third-Quarter Earnings Presentation, slide 5.
AT&T earned $0.94 of adjusted earnings per share during the quarter, topping consensus estimates by $0.02. This was also a 4.4% increase from the prior year. Revenue did decline 2.5% to $44.6 billion, which was $485 million lower than expected.
Revenue for the Communications segment was flat at $17.7 billion. EBITDA grew 1.6% and EBITDA margins improved 80 bps. Wireless service revenues were up 0.7% on phone growth of 255K net adds. Post paid churn was just 0.95% and average revenue per user increased 0.6% to $55.89.
The Entertainment Group’s revenue was lower by 3.4%, though EBITDA margins were up 40 bps due in part to a 3.9% reduction in expenses. IP Broadband revenues increased 3.5% and AT&T Fiber net adds came to 318K. AT&T did see a loss of 1.2 million premium video subscribers due to the ending of heavily discounted plans and promotions. Business Wireline declined 3% and EBITDA margins were lower by 160 bps.
The Warner Media segment declined nearly 5% year over year to $7.8 billion. The primary reason for this decline was due to a strong comparison against Q3 2018, where the company released a strong slate of movies.
HBO revenues increased almost 11% with especially strong performance for international content. Higher subscription revenues offset lower advertising and content licensing revenues for the Turner business. Latin America sales were up 4% on a currency constant basis to $1.9 billion. EBITDA increased 21% due to improvements in Mexico as AT&T had 600K net adds from the region.
Consensus estimates call for earnings per share of $3.56 for 2019. This would represent growth of 1.1% from the previous year.
AT&T provided initial guidance for 2020 as well. The company expects revenue between $184 and $186 billion for the year and earnings per share to fall in a range of $3.60 to $3.70. Both estimates are above what analysts had been expecting.
Growth Prospects & Competitive Advantages
AT&T’s primary competitive advantage, and one that is likely to lead to future growth, is the sheer number of customers that it connects with through its various business segments. Nearly 170 million customers use at least one of the company’s products or services. This gives the company a wide install base. This makes the 0.6% increase in revenue per user that the company had in the most recent quarter a significant figure.
Another advantage the company has over others is that its network is widely popular with consumers. While AT&T’s Mobility business had flat revenue growth for the quarter, this segment had solid phone net adds and EBITDA growth. Consumers also see the company has one of the best wireless carriers in the market place as evident by its record low third-quarter churn rate of 0.95%.
Finally, AT&T free cash flow gives it one last significant advantage over its competitors. The company has generated almost $21 billion of free cash flow through the first three quarters of the year. And the company has used that cash to pay dividends and lower its debt position.
AT&T had to take on a sizeable amount of debt to fund recent acquisitions, with DirecTV and Time Warner adding a combined $40 billion in debt to the company’s balance sheet. Following these transactions, AT&T had total debt of ~$190 billion and had a net-debt-to-adjusted-EBITDA ratio of 3x.
The company has managed to use its abundance of free cash flow to help pay this down to a much more manageable level. At the end of the third quarter of 2019, debt stood at ~$165 billion.
AT&T expects to pay off three quarters of the debt from the Time Warner acquisition by the end of this year and to completely erase this debt by the end of 2022. The company expects that its net-debt-to-adjusted-EBITDA ratio will fall to 2.5x by the end of 2019.
AT&T is also exploring asset sales to help drive down debt even faster. The company sold its stake in Hulu for $1.4 billion on 4/15/2019 and used the proceeds to reduce its debt levels.
Following an activist investor taking a stake in the company, AT&T will undergo a strategic review to identify segments that no longer fit with its core businesses. AT&T expects to sell up to $14 billion worth of assets by the end of 2019.
This debt reduction will improve the company’s balance sheet and also offer it the ability to make another acquisition, if needed, to help it grow even further.
Besides offering guidance for next year, AT&T also presented its outlook for the next three years.
Source: AT&T’s Third-Quarter Earnings Presentation, slide 5.
Revenue growth is expected to be a pedestrian amount, but this isn’t entirely shocking for those following AT&T.
What should stand out is the company’s aggressive forecast for adjusted earnings per share over the next few years. While next year’s estimate is barely above expected results for this year, 2022 forecast is rather aggressive. Achieving the midpoint of this 2022 estimate would result in 31% growth from estimates for the current year. Considering that AT&T has compounded earnings at a rate of just 2.2% from 2007 through 2018, this level of growth is rather unheard of for the company.
Helping to reach these growth rates are the company’s acquisitions in recent years. None is more important - Time Warner in 2018 is its most important. This addition added Warner Bros, HBO and Turner to the company.
These assets should only continue to add to AT&T’s results going forward. A good example of this is Warner Bros.’ “Joker,” which has made almost $860 million since being released in early October. This makes “Joker” the seventh highest-grossing film of all-time and the top-grossing R-rated film in history.
AT&T also announced on 10/29/2019 that it will be pricing its HBO Max subscriptions at $14.99 per month when the service launches in May of 2020. This streaming service, which will be free to current subscribers of HBO, will launch with 10,000 hours of content and shows. AT&T will spend $4 billion over the next three years to help develop at least 50 original shows. AT&T expects HBO Max to add $5 billion to annual revenues by 2025.
It’ll be assets like these that help propel future growth for AT&T.
Many investors own AT&T because of its dividend yield, but the company is also viewed as recession-proof because of the services it offers. Customers are likely to cut back on spending during a recession, but they will most likely maintain their phone and TV packages.
Listed below are AT&T’s adjusted earnings per share before, during and after the last recession:
- 2007 adjusted earnings per share: $2.76
- 2008 adjusted earnings per share: $2.16 (22% decline)
- 2009 adjusted earnings per share: $2.12 (2% increase)
- 2010 adjusted earnings per share: $2.29 (8% increase)
- 2011 adjusted earnings per share: $2.20 (4% decline)
- 2012 adjusted earnings per share: $2.33 (6% increase)
Like most companies, AT&T did see a drop in profitability during the last recession. This decline was more than erased the following year. The next few years showed some years of decline as well as growth, but the company, however, didn’t make a new high for adjusted earnings per share until 2016.
Despite this, AT&T continued to raise its dividend during this period of time. Because AT&T's dividend has proven to be resilient to recessions, it is even more appealing for income investors.
Even after shares of AT&T have returned more than 29% this year, the stock still offers a dividend yield of 5.4%. This is almost three times the average yield of the S&P 500. This offers investors a very generous level of income on top of the share price appreciation that has taken place in 2019.
AT&T has increased its dividend with a compound annual growth rate of:
- 1.4% over the past three years.
- 1.7% over the past five years.
- 2.0% over the past 10 years.
The company often raises its dividend by $0.01 per share per quarter. This has been the pattern for more than a decade. AT&T continued that streak when it increased its dividend by 2% for the 2/1/2019 payment. This marks 35 consecutive years of dividend growth.
While the dividend growth might be minimal, investors can rest easy knowing that the payout ratios are very low. Using the annualized dividend of $2.04 and expected earnings per share for the year of $3.56, the earnings payout ratio is 57%. This gives AT&T plenty of room to continue to offer $0.01 per quarter raises going into the future.
Using free cash flow to measure dividend safety reaffirms this view. AT&T generated $11.4 billion of cash flow from operating activities in the third quarter and spent $5.2 billion on capital expenditures during the same time period for free cash flow of $6.2 billion. The company distributed $3.7 billion of common share dividends during the same time period for a free cash flow dividend payout ratio of 60%.
Looking out over a longer time horizon, the payout ratio is lower. AT&T generated $36.7 billion of cash flow from operating activities through the first three quarters of the year and spent $15.7 billion on capital expenditures for free cash flow of approximately $21 billion. The company distributed $11.2 billion of common share dividends during the same time period for a free cash flow dividend payout ratio of 53%.
Telecommunications companies often have enormous capital expenditures as they build out and upgrade their systems, but AT&T also produces a lot of free cash flow that can be used to pay a generous dividend yield while at the same time paying down debt. These payout ratios also make it likely that AT&T can continue to increase its dividend even during the next recession.
AT&T had a mixed third-quarter earnings report. Adjusted earnings per share increased, but revenue was down from the prior year. Communications was flat, but had pockets of growth, such as double-digit improvement in HBO revenues.
The company also expects adjusted earnings per share to accelerate over the next three years and has several levers with which to pull to achieve this aggressive forecast.
AT&T also held up decently during the last recession and offers a generous and well-covered dividend yield. For these reasons, AT&T appears to be much more than just an income story. To us, the combination of potential for growth, yield and recession performance makes AT&T one of the most attractive Dividend Aristocrats.
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.