Seeking Alpha

Moving To 'Dividend Buy' On AT&T, A Great Income Generator In A Low Interest Rate Era

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About: AT&T Inc. (T), Includes: AAPL, AMZN, NFLX, ROKU
by: Cestrian Capital Research
Summary

We believe AT&T is one of the safest sources of income in this low interest rate era.

Even as the company has built up debt acquiring what are in our view non-core businesses, it has continued to increase its dividend - safely.

We believe the outlook for AT&T's dividend is solid.

We further believe rates are unlikely to rise significantly any time soon, which we think will make AT&T an attractive stock for some time.

Disclaimer: This article is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this article is not an offer to sell or buy any securities. Nothing in it is intended to be investment advice and it should not be relied upon to make investment decisions. Cestrian Capital Research Inc or its employees or the author of this article or related persons may have a position in any investments mentioned in this article. Any opinions or probabilities expressed in this report are those of the author as of the article date of publication and are subject to change without notice.

Summary - AT&T, Everyone's Favorite Dividend Hero

It is news to no-one that AT&T (T) is a dividend hero. Everyone knows the company, everyone knows it is a solid income generator, and many people know that it has successfully levered up and delevered around large acquisitions such as DirecTV and Warner Media.

T followers will likely have an eye on the capital gain potential with the stock. It's had a good run, and the presence of Elliot Advisors in the shareholder register is likely a positive. The stock looks like it could stay in the mid to high 30s for some time; breaking 40 appears to be a challenge.

Here we concentrate not on the capital gain potential, but on the strategy of using T stock purely as an income instrument. The stock can go up or down after you buy it; given the utility-like nature of what it does, there's not likely to be huge volatility in either direction. So we believe the capital value has a degree of protection around it. The 5% yield is in our view attractive in the light of the safety of the capital value. And in particular, set against the macro backdrop of low rates (which we think will persist for some time), earning 5% from such a stock looks attractive.

We therefore move to "Dividend Buy" on T.

Macro Backdrop

Economic orthodoxy is on shifting sand right now. When monetarism was young and Keynesianism out of favor, the diktat was: growth up, inflation up, rates up. Leading to savings up a little, spending down a little, growth down a little, everything in balance. Economy overcorrects, growth falls too far, rates down, spending up, growth up, inflation up. Rinse and repeat. (This is the Cartoon Network version of monetarist praxis, anyway).

Like all the best grand theories, it worked for a while; Friedman, Hayek et al were hailed, rightly, as geniuses. Runaway inflation in parts of Europe in particular was quelled with the advent of independent central bank control of interest rates. With rate-setting wrenched from the hands of politicians, who naturally use rates as a tool to manage the electoral cycle, an era of calm, bureaucratic reason set in.

When the financial crisis hit, monetarism rode to the rescue. Rates to zero or close thereto, the end of capitalism kept at bay for a spell. More kudos to the Chicago School.

And then, like all the best grand theories, someone figured out how to take advantage of it. Specifically the equity market, collectively, figured out that free money was good. Borrow money for almost nothing. Invest it in variable priced assets. Asset prices rise whilst others do the same. Repeat.

That is the story of the 2009-19 bull run. Money free, asset prices up. Although there has certainly been some benefit to the poor since 2009, this has been predominantly a boon for the rich. For the kindergarten illustration thereof, check US GDP growth vs. S&P500 returns over the period from 1 Jan 2009 to today.

Source: YCharts.com

You can argue whether these measures are the exact right ones all day long but you see the point. Compounded GDP growth of almost 50% since that dark day - well done hardworking Americans; S&P500 return of over 6x that - thankyou Federal Reserve.

Anyone who has invested in equities or real estate over this period ought to have been pocketing fistfuls of cash. It's why passive funds have become so popular. Put money in the S&P, pay minimal fees, go play golf while your money makes more money. Want to spice it up? Borrow some money and put that in the S&P too. Or, getting bored now and seeking a little juice, get yourself into a 3x leveraged S&P ETF. And as scary as that sounds ... you probably did OK from that too! Happy days.

What comes next, nobody knows of course. Economies are cyclical and at some point the US economy will slow and sometime after that it will go backwards for awhile. Our guess is that won't happen right away, we have an electoral cycle to go through and every Administration does its best to hold the election in a growth period - this Administration will be no different.

What's interesting is - when the economy does turn, the Chicago school is out of tricks - and that's because the market has the thumbscrews on the Fed. And when we say the market - we mean investors, traders, ETF providers, your 401k and your grandma's retirement income portfolio too. It's not just Trump blasting Powell - it's everyone. It's just that not everyone Tweets it.

The market has fallen utterly in love with free money, so much so that it throws ALL its toys out the stroller whenever someone suggests that money should maybe cost something.

Another chart for you. Fed funds rate (the upper and lower limits) vs. the S&P500 over the last five years. In essence the market will wear 2% or below. Above that? Not so much.

Source: YCharts.com, Cestrian Analysis.

So when the economy does turn, you can expect rates to come down from their already exceptionally low level.

And when rates come down, where then will folks find income? Answer - from mother. Ma Bell, that is.

Netflix Won't Kill The Dividend Star

For the record, we don't love AT&T's business model right now. We've said so more than once, but if you want a rehearsal of why, click here for our views on why telcos should keep it simple. But despite feeling the need to compete with everyone from Netflix to Apple to Amazon on the content side (see?? you just have to write it down and it's obviously nuts), the company is still generating oodles of cashflow.

Better yet, it is generating so much cashflow that not even this management team and board can find enough things to waste it on. (Maybe they'll buy Roku (ROKU) just for fun).

So that means that even when servicing all the debt from the TV acquisitions, even when the stock price has been on a big run, the company is STILL able to pay an estimated forward yield of >5%. Which is >2x the Fed funds upper limit rate.

Here's how T's dividend yield has played out vs. the Fed funds rate in recent times. Fed low, T high, and vice versa.

Source: YCharts.com

Why Not 10% You Ask?

Usually we dislike dividend-focused analysis targeting super-high yielding stocks, saying "corporation X is paying a dividend yield of Z, wow" because unless you are looking at the very best analysis, the reason is usually because the share price has tanked for some real-world reason or other and the board has yet to cut the dividend. So your forward yield of "wow percent" never quite materializes.

Here you get 5% despite all the bad stuff above about wasting money on TV assets (our opinion) and despite the runup in the stock.

And as T stock seems to be slipping a little right now, and as the company has a history of hiking its dividend, if you play your timing well, you might get nearer 6%. From a company which is safe as houses.

Here's the actual - not kindergarten but actual - dividend hike story over 30+ years. Telco bores will know that AT&T isn't even the same AT&T as existed over that whole time but it doesn't seem to matter. It just keeps on churning out that dividend.

Source: YCharts.com

We Don't See The Fed Raising By Much Any Time Soon

With pressure on the Fed from every constituent in town, and GDP forecasts for the US economy being level or muted - nobody thinks GDP is going to race away - we don't see the Fed raising target rates above 2% any time soon. The fallout would be too painful - look at Q4 last year and look at the Presidential tweetstorm that would follow. (And while the heat and light may come via Twitter, the market speaks with the true power over the Fed). If we're right - and if we're right that T's business is sufficiently dependable that the stock doesn't dip too much even in bad times - then we believe using T as a source of income - savings income essentially - is a sound strategy.

We own T on a personal account basis for exactly this reason.

Cestrian Capital Research, Inc - 26 November 2019.

Disclosure: I am/we are long T, ROKU. 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.

Additional disclosure: We are long T and ROKU on a personal account basis.