- AT&T has raised its dividend for 36 consecutive years and the dividend remains highly sustainable with an adjusted EPS payout ratio around 62% during Q1 this year.
- While adjusted EPS slightly declined in Q1 2020 and FCF declined in Q1 2020, AT&T continues to throw off more than enough cash to meet its upcoming debt maturities.
- In addition, AT&T is trading at a 6% discount to fair value based on data sourced from I Prefer Income, as well as Morningstar's most recent report.
- Between its 6.4% yield, 3.0-4.0% annual earnings growth potential, and 0.6% average annual valuation multiple expansion, AT&T is positioned to meet my 10% average annual total return requirement over the next decade.
In an uncertain operating environment such as the one we currently find ourselves in as a result of COVID-19, it is more important than ever to seek out high-quality companies that have been able to steadily increase their dividends regardless of economic or political conditions.
Filtering for a yield of greater than 6% and for stocks that have raised their dividends for 25 years or more, I was able to narrow down I Prefer Income's database of Dividend Diamonds from 134 to just 5.
Today, I'll be discussing AT&T's (NYSE:T) dividend safety and growth profile since I last covered the stock in March, examining AT&T's recent operating results and the risks associated with an investment in the stock, as well as the valuation aspect of an investment in AT&T by using a couple of valuation metrics and a fair value estimate from Morningstar to determine the fair value of AT&T's shares.
Despite COVID-19, AT&T's Dividend Remains Sustainable
While I believe it is always prudent to examine a stock's applicable payout ratio, it is even more important to do so when a stock's yield is over 3 times that of the S&P 500's as is the case with AT&T.
According to page 27 of AT&T's investor briefing, AT&T generated $8.866 billion in operating cash flow during Q1 2020 against capital expenditures of $4.966 billion, for total FCF of $3.900 billion.
Against the $3.737 billion in dividends paid out during that time, this equates to an FCF payout ratio of 95.8%.
Although AT&T's respective payout ratios of 61.9% and 95.8% for the first quarter of this fiscal year were considerably higher than the 57.1% and 50.9% payout ratios during last fiscal year, it's impressive that even with the loss of live sports the last month of the quarter and resulting drop off in advertising revenue within the WarnerMedia segment, AT&T was still able to cover its dividend with adjusted EPS and FCF.
The fact that AT&T was able to cover its dividend in the most challenging operating environment in recent memory reinforces my argument that AT&T's dividend remains fairly safe for the foreseeable future.
With AT&T's dividend safety addressed, I'll now turn my attention to my growth expectations for AT&T's dividend over the long-term.
Given that AT&T was able to grow its earnings by 8.9% annually over the past 5 years and that Yahoo Finance is forecasting 2.4% annual earnings growth over the next 5 years (a bit below my 3-4% forecast), I believe that a long-term dividend growth rate at the low-end of my forecast of 3% is a reasonable expectation.
AT&T Delivered Decent Operating Results Considering COVID-19's Widespread Impact
Image Source: AT&T Investor Update - Q1 2020 Earnings Presentation
Through the lens of the widespread impact that COVID-19 has had throughout most sectors of the economy, I consider AT&T's recent operating results to be satisfactory.
Starting with revenue, AT&T reported a 4.6% YoY reduction from $44.8 billion in Q1 2019 to $42.8 billion in Q1 2020.
This isn't a surprise given that AT&T's WarnerMedia segment is dependent on the theatrical and TV side, which was unfavorably impacted by COVID-19 shutdowns of production studios and movie theaters, as well as less advertising revenue, according to incoming CEO and current COO John Stankey's opening remarks during AT&T's Q1 2020 earnings call.
AT&T's adjusted EPS declined 2.3% from the $0.86 generated in Q1 2019 to the $0.84 generated in Q1 2020.
Although this appears negative at first glance, it's encouraging to note that according to CFO John Stephens' opening remarks during AT&T's Q1 2020 earnings call, AT&T's adjusted EPS was $0.89 when factoring in the $0.05 impact of COVID-19.
Delving into more detail, AT&T's Communications segment performed well in the midst of COVID-19, allowing the segment to post EBITDA of $12.8 billion, which was up 2.4% from the $12.5 billion generated in Q1 2019.
These strong segment results were due to the continued demand for AT&T's services in the midst of the COVID-19 pandemic, which allowed AT&T to grow its Mobility service revenue by 2.5%, according to CFO John Stephens in AT&T's Q1 2020 earnings call. As a result of the strong EBITDA margin expansion and revenue growth, Mobility posted a 7% YoY increase in EBITDA from the $7.3 billion generated in Q1 2019 to $7.8 billion generated in Q1 2020.
Within the Entertainment group, 209K AT&T Fiber subscribers were added during the quarter, which helped AT&T to surpass 4 million subscribers, as indicated by CFO John Stephens in AT&T's Q1 2020 earnings call. The additions in AT&T Fiber subscribers were slightly more than offset by the loss of 897K premium video net losses, although this improved sequentially, according to CFO John Stephens.
As a result of the above activity within the Entertainment group, the segment posted a 7.1% decline in revenue YoY from the $11.3 billion generated in Q1 2019 to $10.5 billion generated in Q1 2020, and a 7.1% decline in EBITDA YoY from the $2.8 billion in Q1 2019 to $2.6 billion in Q1 2020.
Rounding out the Communications segment, AT&T's Business Wireline group was able to mostly offset the unfavorable impact of the continued decline of its legacy products with growth in its strategic and managed services, according to CFO John Stephens.
This allowed the Business Wirelines group to post a 3.1% YoY decline in revenue from the $6.5 billion in Q1 2019 to $6.3 billion in Q1 2020. AT&T's EBITDA was roughly unchanged as a result of the small decline in revenue and 20 basis point decline in EBITDA margin within the segment.
As a result of no live sports and resulting decreased advertising revenues, as well as production studio and movie theater shutdowns stemming from COVID-19 as discussed earlier, WarnerMedia's revenue sunk 11.9% from $8.4 billion in Q1 2019 to $7.4 billion in Q1 2020.
Paired with the reduction in EBITDA margins, WarnerMedia's EBITDA declined roughly 25% YoY from $2.4 billion in Q1 2019 to $1.8 billion in Q1 2020.
Wrapping up AT&T's segment by segment results, the Latin America segment's revenue was a bit lower (down to $1.6 billion in Q1 2020 from $1.7 billion in Q1 2019) in spite of Vrio's strong showing for the quarter, which was a result of economic and foreign exchange headwinds, as indicated by CFO John Stephens.
This resulted in the Latin America segment posting a significant reduction in EBITDA, from the $127 million generated in Q1 2019 to $93 million in Q1 2020.
Transitioning to AT&T's liquidity position, AT&T's debt maturities of $10-$11 billion over the next 4 years are very manageable when considering that last year, AT&T generated over $14 billion in retained FCF when factoring in the $15 billion in dividends paid out last year.
Even factoring in a significant reduction in AT&T's FCF this year due to COVID-19, AT&T is positioned to pay its maturities without accessing the debt markets, according to CFO John Stephens' opening remarks during AT&T's Q1 2020 earnings call.
AT&T's cash position was a respectable $10 billion as of the end of Q1 2020 and will be bolstered due to a $5.5 billion term loan taken by the company in April, as indicated by CFO John Stephens.
As a result of AT&T's strong cash position, the $15 billion revolver that the company doesn't anticipate it will have to use, and its suspended share buyback program, it's reasonable to conclude that AT&T's liquidity is more than enough to weather COVID-19.
Image Source: AT&T Debt Details
AT&T boasts Baa2, BBB, and A- credit ratings from Moody's, S&P, and Fitch, respectively, on stable credit outlooks, according to its debt details page.
Based on the previous slide detailing AT&T's strong liquidity and the company's strong cash flow generation even during a difficult operating environment, it shouldn't come as a shock that AT&T maintains investment grade credit ratings from the major credit rating agencies.
When I take into consideration AT&T's results in spite of a challenging COVID-19 operating environment, AT&T's liquidity position and investment grade credit ratings on stable outlooks from the major ratings agencies, I believe AT&T is capable of being a great long-term investment if shares are acquired at or below fair value.
Risks To Consider:
Even though AT&T has proven itself as a reliable income stock over the past several decades, it is important that both potential and current shareholders monitor AT&T's risk profile to ensure that the investment thesis remains intact. I'll be providing more immediate risks facing AT&T as a result of COVID-19 and the disruptions to life throughout the world that occurred shortly after my previous article on AT&T was published.
I will be referencing page 56 of AT&T's most recent 10-Q rather than AT&T's 10-K as the risks outlined in AT&T's most recent 10-K remain the same and I have covered them in detail in my previous article.
The risks posed by COVID-19 are multi-faceted, and include both operational risks and financial risks.
The disruptions of COVID-19 have caused the avoidance and closure of movie theaters and resulted in interruptions in movie production and other programming.
Should these disruptions to programming continue into the future, AT&T's financial results could be harmed over the long-term as movie releases are delayed and box office success is hampered by an avoidance of movie theaters even after COVID-19 dissipates.
Another risk within the WarnerMedia segment that applies to COVID-19 is the cancellation of sporting events, such as the NCAA college basketball March Madness tournament, as well as the disruptions to the NBA and MLB.
If future pandemics that prompt shutdowns manifest themselves, AT&T could be adversely affected yet again.
Fortunately, the NBA recently announced its plan to restart its season toward the end of July, which will help WarnerMedia to get its advertising revenues back on track at TBS and TNT.
And although there are still issues that need to be resolved between MLB owners and players before the MLB season begins, it appears as though the season will begin in the coming weeks, which will be yet another help to TBS.
On the Business Wireline front, it is crucial that the economy makes a strong recovery or AT&T risks having its most significantly impacted customers reduce or terminate their services, which would adversely impact the segment's revenue and EBITDA.
Another risk to this segment, is that even well after mitigation measures subside, the prolonged closure of stores could discourage customers from accessing AT&T's stores, which could negatively impact operating and financial results within the segment.
Another risk to AT&T as a result of the pandemic, is that staffing levels at call centers and field operations could result in delays in service and a deterioration in AT&T's customer service, which could negatively impact AT&T's competitive position, causing long-term damage to the company's reputation and financial results.
One final and broader risk resulting from the COVID-19 pandemic and disruptions to the economy, is that the global economy doesn't recover as quickly as anticipated, which could challenge AT&T with headwinds of heightened unemployment, reduced consumer spending, and reduced consumer confidence.
Needless to say, the prolongation of these headwinds would materially impact AT&T's operating and financial results.
Although I have provided several key risks associated with an investment in AT&T that have manifested themselves since my previous article, I haven't discussed all relevant risks facing AT&T. For a more complete discussion of the risks associated with an investment in AT&T, I would refer interested readers to pages 15-21 of AT&T's most recent 10-K and my previous articles on the stock.
AT&T Is Still A Blue-Chip Trading At A Slight Discount
While AT&T is a Dividend Aristocrat that has created meaningful wealth for long-term shareholders, that doesn't mean an investor can pay any price for shares of AT&T and expect to do well. As with any stock, if shares of AT&T aren't acquired at or below fair value, shareholders are exposed to the risks of a lower than usual starting yield and the possibility of valuation multiple contraction.
Employing this logic, I'll be using a couple of valuation metrics and a fair value estimate from Morningstar to arrive at a fair value for shares of AT&T.
The first valuation metric that I will use to establish a fair value for shares of AT&T is the yield to historical yield.
According to I Prefer Income, AT&T's current yield of 6.35% is well above its historical yield of 5.46%.
Assuming a reversion in AT&T's yield to a fair value yield of 5.50% and a fair value of $37.82 a share (which I believe appropriately factors in AT&T's increased size and scale going forward), shares of AT&T are trading at a 13.4% discount to fair value and offer 15.5% upside from the current price of $32.74 a share (as of June 7, 2020).
The next valuation metric that I'll be utilizing to determine the fair value of shares of AT&T is the PE to historical PE ratio.
Factoring in a reversion in AT&T's PE ratio to its historical PE ratio and a fair value of $29.95 a share, shares of AT&T are priced at a 9.3% premium to fair value and pose 8.5% of capital depreciation from the current price.
The valuation method that I'll be using is Morningstar's June 6 report on AT&T, via my subscription to Robinhood Gold.
Based off Morningstar's report on AT&T's fair value of $37.00 a share, shares of AT&T are trading at an 11.5% discount to fair value and offer 13.0% upside from the current price from the current price.
When I average the three fair values above, I compute a fair value of $34.92 a share, which implies that shares of AT&T are priced at a 6.2% discount to fair value and offer 6.7% of capital appreciation from the current price.
Summary: AT&T Is Positioned To Deliver Modest Growth With A Strong Yield
AT&T has delivered 36 consecutive years of dividend increases, which underscores the company's ability to generate sufficient cash flow to pay rising dividends to shareholders while also tending to its capital expenditures.
When I consider how AT&T has held up in a difficult operating environment to date and AT&T's ample liquidity, I believe it is reasonable to expect many more years of low-single digit dividend growth ahead.
Adding to the case for an investment in AT&T, is the fact that the stock is trading at a modest discount to fair value based on my interpretation of I Prefer Income's valuation metrics and Morningstar's most recent report on the stock.
Between its 6.4% yield, 3.0-4.0% annual earnings growth potential, and 0.6% average annual valuation multiple expansion, AT&T is positioned to meet my 10% average annual total return requirement over the next decade.
It's the foregoing reasons that serve as my rationale to continue rating shares of AT&T as a buy at the current price.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.