Seeking Alpha

AT&T: A Conviction Pick For 2020

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About: AT&T Inc. (T)
by: Robert & Sam Kovacs
Robert & Sam Kovacs
Long only, dividend investing, dividend growth investing
Summary

AT&T has outperformed the market since we last suggested purchasing shares.

I am becoming exceedingly cautious in 2020 with markets getting higher and higher.

Yet AT&T offers the right combination of dividend strength, value, momentum and quality to warrant a conviction pick for the year.

Written by Robert Kovacs

Introduction

Beating the market by investing in AT&T (T)? Most would say it is impossible, or at least highly unlikely. During the past decade, AT&T's share price increased by 42% while the S&P 500 surged over 180%. If we considered dividends, the gap between T and the market would narrow, but only slightly. Nobody thinks of T as a stock which will outperform the market.

Source: Open Domain

Yet, had you invested in T in August when I suggested that it was time to pull the trigger, your total return would be of 13%, while the S&P 500 would have returned only 11%.

Source: Seeking Alpha

This goes to show that when you get the timing right, you can beat the market even by buying the dullest of dull dividend stocks.

We invested cautiously throughout 2019. In 2020 our caution remains. Markets are expensive, and bargains are few and far between (although never non-existent). We expect 2020 to be a year where we continue to take profits in many positions and consolidating our portfolios towards a core of fairly priced, defensive stocks.

Therefore we will start this year with a few of our "conviction buys for 2020". And I will start with T. All of the stocks we cover will have the following in common: we believe they will beat the S&P 500 whether we have a down, up or flat market. This cannot be taken likely. For instance, some of our favorite picks in the consumer discretionary area cannot be expected to outperform in a down market. Likewise most of our picks in the energy sector will struggle to beat the market in an up market.

Yet, there are a handful of stocks which we believe provide both good downside protection in a bear market and more upside potential in an up market.

AT&T is such a stock.

T is currently trading at $39.06 and yields 5.22%. My M.A.D Assessment gives T a Dividend Strength score of 83 and a Stock Strength score of 88.

I believe that dividend investors can add more AT&T at current prices, provided the stock doesn't exceed planned weightings in your portfolio.

Source: mad-dividends.com

As I always like to do, I will go through the stock's dividend profile before analyzing fundamental factors to determine potential for capital appreciation. This sets the tone for the organization of all my articles: dividend strength first, stock strength second.

Dividend Strength

A strong dividend stock is one which combines dividend safety and dividend potential. Dividend safety can be defined as the likelihood that the dividend will be maintained in upcoming quarters. Dividend potential can be defined as the combination of dividend yield and dividend growth. The higher the dividend yield, the lower the dividend growth potential. I explain the mechanics of this in my article "Dividend Investing Strategy For Individuals Like You & Me" (I made the article an "Author's pick so you can access it unconditionally).

Dividend Safety

AT&T has an earnings payout ratio of 92%. This makes T's payout ratio better than 20% of dividend stocks.

T pays 31% of its operating cash flow as a dividend, which is better than 45% of dividend stocks.

T pays 73% of its free cash flow as a dividend, which is better than 31% of dividend stocks.

30/09/2015

30/09/2016

30/09/2017

30/09/2018

30/09/2019

Dividends

$1.8700

$1.9100

$1.9500

$1.9900

$2.0300

Net Income

$0.31

$2.38

$2.08

$5.29

$2.21

Payout Ratio

604%

81%

94%

38%

92%

Cash From Operations

$9.76

$6.20

$6.37

$5.65

$6.63

Payout Ratio

20%

31%

31%

36%

31%

Free Cash Flow

$3.74

$2.00

$1.91

$1.64

$2.79

Payout Ratio

50%

96%

102%

121%

73%

Source: mad-dividends.com

AT&T is a cash machine. Looking at earnings payout ratio would mask the fact that the company generates enough cash from operations to pay the dividend more than 3 times. After CAPEX is considered, there is enough cash to pay the dividend 1.36x. This is entirely satisfying given that we know AT&T's quarterly dividend will only increase by $0.01 each year. Like I mentioned last time I wrote about AT&T, we expect CAPEX to come down, as well as management to start retiring stock (up to 9% over 3 years if we refer to the latest earnings call). This will simultaneously increase free cash flow and decrease the amount of dividends the company pays.

This should clear any doubt concerning AT&T's dividend. It has been going for the last 35 years, and while I cannot see as far as 35 years in the future, I am as sure as ever that it will be paid for at least the next 3 to 5 years, and very likely well beyond that. In terms of safe dividends, AT&T is right up there with the best.

Dividend Potential

AT&T has a dividend yield of 5.22% which is higher than 85% of dividend stocks. T has long been a high yielding stock. For the past decade the yield has averaged 5% (10 year median yield of %). For yields between 5% and 5.5%, I only need very modest amounts of dividend growth to be satisfied, to the tune of 2% per year.

Source: mad-dividends.com

In December, the company announced an increase from $0.51 per quarter to $0.52. This 2% increase is in line with the company's 5 year CAGR of 2%.

Source: mad-dividends.com

The growth has been more than backed by growth in AT&T's top line which has increased at a 4% CAGR during the last 3 years.

Source: mad-dividends.com

With this in mind, I still strongly believe that AT&T's dividend will continue to increase at the same steady eddy rate of $0.01, once each year. While the company isn't a fast grower, it is a steady grower with many interesting prospects, from HBO MAX to 5G coming on board.

Dividend Summary

T has a dividend strength score of 83 / 100. The dividend is safe. My recommendation for T has always been that it is a great buy for income purposes above a 5% yield. But this information alone would only have prevented you from purchasing T when it was at its most expensive at different times in 2012, 2013, 2016 and 2017. Mind you that's already not bad, but not sufficient if on top of great income you want to beat the market.

The next section will focus on those dynamics.

Stock Strength

While dividend strength focuses on the attractiveness of the dividend policy, stock strength is only concerned with a stock's potential for capital appreciation. To assess this we look at four factors: value, momentum, financial strength and earnings quality. Each of these factors have been proven to generate excess returns by James O'Shaughnessy in his book "What Works On Wall Street". We use our variation of these factor scores, which we call our MAD Scores, to assess a stock's likelihood of beating the market.

Value

  • T has a P/E of 17.67x
  • P/S of 1.58x
  • P/CFO of 5.89x
  • Dividend yield of 5.22%
  • Buyback yield of -0.49%
  • Shareholder yield of 4.73%.

According to these values, T is more undervalued than 90% of stocks, which is very satisfying. Even after having increased 12%, T's price remains very attractive. This is even more compelling when you consider that over the next year, we can expect anywhere from 2-4% of shares to be repurchased, pushing the forward shareholder yield to 7-9%. What's more, and this always baffles me: T trades at less than 6x operational cash flow or 14x FCF. Even its multiples of 17x earnings looks reasonable in a market which commands a multiple of 24x earnings. I believe T is chronically undervalued, and has been for most of the past decade.

While Elliott management thinks T is worth over $60 per share, I think $50 is a more reasonable estimate, and think 10% appreciation from current price is a plausible target for 2020. This would push T's yield down to 4.86% and price up to $42.9. Such a price has already been seen for a brief period in 2016, proving that the market has been willing to price T at such a level in the past. T is in better shape than in 2016, having paid down debt, increased the dividend multiple times and having grown its business since.

Value Score: 90 / 100

Momentum

AT&T trades at $39.06 and is up 4.13% these last 3 months, 14.95% these last 6 months & 28.74% these last 12 months.

Source: mad-dividends.com

This gives it better momentum than 66% of stocks, which is encouraging. The stock has good 12 month relative strength, great 6 month relative strength, but only modest 3 month strength. The stock has experienced resistance at the $40 level but repeatedly found support off its 20 day SMA. Over the next few weeks, T will have the opportunity to break through $40 again. A good 4th quarter report at the end of the month could be the catalyst to push through the $40 level.

Source: mad-dividends.com

In the meantime, the price remains above the 20 day SMA, which itself is above the 50 day, which is above the 200 day. This remains a bullish setup for T, and good news could push the stock through the $40 mark. After that, if the price can stay above that level, it could easily push through towards $43-$45 where it would once again encounter resistance.

Momentum score: 66 / 100

Financial Strength

T has a gearing ratio of 1.8, which is better than 42% of stocks. The company's liabilities have increased by 1% over the course of the last 12 months. The company's operating cash flow can cover 13.8% of liabilities. This makes T more financially sound than 70% of U.S. listed stocks. As you would expect, T's financial strength profile hasn't changed much since we last analyzed the stock last summer. Many fret over the sheer amount of debt AT&T has, but when you look at the gearing ratio, or the liability coverage, you don't see a company which is crawling under debt. Investors would be well served by keeping proportions in mind: relative to its cash flow generation, AT&T has slightly less liabilities than the median US stock: This is good.

Financial Strength Score: 70/100

Earnings Quality

T has a Total Accruals to Assets ratio of -8.9%, which is better than 52% of companies. It depreciates 147.6% of its capital expenditure each year, which is better than 62% of stocks. Finally each dollar of assets generates $0.3 in revenue, which is better than 38% of stocks. This makes T's earnings quality better than 56% of stocks.

Earnings Quality Score: 56 / 100

Stock Strength Summary

When combining the different factors of the stock's profile, we get a stock strength score of 88 / 100 which is very satisfying. While AT&T's momentum has somewhat slowed down in the past quarter, I expect it to be ignited by a good fourth quarter report. This in itself could push the stock above the $40 mark. My target for 2020 is $43 or up 10%. My worst case scenario would have T back down at the $35 mark, while my best scenario would have the price test the $45 level.

Conclusion

With a dividend strength score of 83 & a stock strength of 88, AT&T is a great choice for dividend investors. It is one of our conviction picks for 2020, and deserves an overweight place in our portfolios.

We have made and continue to make lots of suggestions on Seeking Alpha. It can sometimes be difficult to keep track of all of our suggestions, which is why we have created a hypothetical portfolio which you can access at all times at app.mad-dividends.com.

It is hypothetical because it tracks a $10,000 investment each time we make a suggestion on Seeking Alpha, and doesn't include any of the portfolio management and sizing tools we use. But this brings a certain level of transparency to the process, forcing us to remain accountable for our picks here on Seeking Alpha. For instance, as you can see in the screenshot above, our two suggestions to purchase AT&T resulted in a 13% total return.

We recently reviewed all of our 2019 articles in a piece called "Year 2019 On Seeking Alpha: Robert & Sam's Review".

If you liked this article and would want to hear more about our 2020 picks, please click on the orange "Follow" button which is located at the top of the page.

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.