- Bears focus on the company's debt levels and TV subscription losses.
- The company's history proves debt levels are manageable and the dividend is safe, and so is its dividend growth advantage.
- HBO Max provides synergies seldom discussed by analysts.
- AT&T remains one of the best SWAN Dividend Aristocrats that retirees can trust.
- Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »
AT&T: The More It Drops The More I Buy
Co-produced with Chuck Walston
AT&T (NYSE:T) is a dividend growth stock that currently yields close to 7%. There are those in the investment community that believe AT&T is a moribund business, and we see many negative reports about this company.
We acknowledge some of the issues raised with AT&T, but the bears are overlooking many developments that will lead to a steady recovery. We think the debt load is over-emphasized, and the synergies associated with HBO Max are misunderstood and underappreciated. We also see many positives for this company that are missed by many commentators.
(This article was first published to HDO subscribers on March 29th, and all data is from that date.)
The primary reason for my attraction to AT&T and Verizon (VZ) is that the companies provide a robust dividend, and each operates as a member of an oligopoly. I contend that when considering the wireless side of the business, T, VZ, and T-Mobile (TMUS) have an enduring moat.
This leads us to ask which of the three is the dominant operator. The answer might surprise you.
The chart below provides a snapshot of the wireless subscriber market share held by the three major providers. Note: Sprint's share of the market is included in T-Mobile's totals.
Source: Statista/Chart by Author
With the exception of Q2-19, AT&T's market share increased each quarter. Meanwhile, the share of both rivals slowly but steadily eroded.
This segues into another arena that reveals a competitive advantage. The following table records the postpaid churn rate for each firm.
Source: Company reports/Chart by Author
Verizon is the clear winner here, but there are two takeaways from the results. Note the churn is generally in decline for each company. This likely validates the claims of a number of analysts predicting cutthroat competition between the trio would lessen once the Sprint/T-Mobile deal was consummated.
More important is that the decline in churn recorded by AT&T began in Q2 2020. Note HBO Max was launched toward the end of that quarter. There is a significant drop in churn in Q3 2020. We don't think it was a coincidence AT&T recorded the lowest churn rate in the company's history in the quarter following the debut of HBO Max.
And when you add into the mix the customers on select unlimited plans will get HBO Max for free, it's a great opportunity to also improve our overall churn, which we've seen happen from giving HBO to current unlimited customers. A reduction of 1 basis point of wireless churn across the base is worth about $100 million to us annually. - AT&T's John Stankey
That record-breaking churn rate in Q3 was followed by the second-best churn in the company's history the following quarter.
The graph below depicts AT&T's churn rate over nearly a half-decade and highlights the recent improvement in that metric.
Source: Data Business Quant/Chart by Author
The rollout of HBO Max was roundly criticized, and rightfully so. AT&T did not partner with Comcast (CMCSA), Roku (ROKU), or Amazon (AMZN) Fire TV until after the launch. As if to add insult to injury, at least in the eyes of consumers, Max also launched without 4K, or 4K HDR support and sans 57 movies and television shows advertised as part of the service.
The initial results from the rollout led many pundits to opine that HBO Max would languish while competitors' offerings would surge ahead; however, now that AT&T reached an agreement with the full panoply of distributors, HBO Max is outperforming major rivals in terms of recent growth.
Source: Civic Science/Chart by Author
According to a report by Kantar, HBO Max garnered the largest share of new subscribers in Q4 with nearly 8.6 million added to its rolls. In one quarter, HBO Max passed Apple TV+, and ESPN+, and stands within three percentage points of surpassing Showtime's share.
There are reasons to believe HBO Max has a lengthy growth runway. According to eMarketer, the number of US households that subscribe to streaming services is set to increase to 205.6 million consumers in 2023 versus 182.5 million in 2019. Meanwhile, the global streaming market is projected to grow from $46.4 billion in 2019 to $86.8 billion in 2024, a 13.4% CAGR.
That is encouraging considering HBO Max is currently available only in the U.S. AT&T announced plans to roll the service out to Latin America and the Caribbean this coming June, with a debut in Europe planned later this year. Management subsequently increased the projections for the number of HBO Max global subscribers in 2025 from a previous estimate of 70 to 80 million to the current forecast of 120 million to 150.
The company now projects HBO Max revenue will more than double by 2025.
Addressing The Debt And Dividend
Due to the costs associated with the acquisitions of DirecTV and Time Warner, there are claims the dividend is imperiled. While we agree that concern over the debt is warranted, we believe a review of the company's historic debt levels should allay investors' fears.
The following chart provides the company's Debt/Equity ratio for the last quarter of each year. To give some context, we added a second chart reflecting Verizon's debt ratios during the same period.
Source: Metrics both charts from Macrotrends/Charts by Author
Using the current ratio to judge AT&T's debt shows the level at the end of 2020 was in line with the norm over the last decade. Verizon's debt levels were generally higher than those of AT&T, and there are only two years when that company's debt/equity ratio was below AT&T's 2020 level.
By closing a deal with private equity firm TPG, AT&T will spin-off DirecTV. The company will receive $7.8 billion from TPG that will be used to retire debt. The spinoff, NewDirecTV, will also assume $200 million in debt.
In Q3-20, AT&T restructured the debt, resulting in a 50% reduction in maturities over the next five years. The average interest rate fell from 4.3% to 4.1%, and the debt ladder was stretched out over 17 years versus the previous 13.
Source: 3Q-20 Earnings Presentation
Unfortunately, due to costs associated with the recent 5G auction, efforts to lower debt will be stymied over the short term, since AT&T added roughly $6 billion in net debt due to the spectrum auction.
Management has a 2021 debt-to-adjusted EBITDA goal of 3.0 with a longer-range target of 2.5 by 2024.
Considering free cash flow for the next fiscal year is projected at $26 billion, and the forecast for the dividend payout ratio is likely to be below 60%, we consider the dividend safe, and so is its dividend growth advantage.
As we compose this line, the shares of T trade around $30. The average 12-month price target of 23 analysts that cover the stock is $31.82, and we believe that their target is very conservative.
An important point to note here is that even if the price target is correct, most of us who invest in AT&T do so for the recurrent big dividend that grows every year.
AT&T's forward Price/Earnings (P/E) ratio is Low at only 9.3 times in a market where most quality stocks are trading well above 20 times. Note that the forward P/E of the S&P 500 companies is currently at 28 times according to the Wall Street Journal. This gives us a lot of confidence that we are getting into this stock at a good and cheap price.
Also looking at another valuation metric, which is EV (Enterprise Value) to EBITDA, the ratio is only at 8 times. This is a unique valuation metric that takes into account the debt levels (which many pundits consider high, and it is clearly over-accounted for in the valuation ratio). Reasonable valuations for solid companies such as AT&T based on this metric is usually at 10 to 12 times. This gives the stock at least 30% to 40% upside potential once some growth starts to kick in.
Low Price Volatility
One great aspect of owning AT&T is that it carries lower market volatility. This is a defensive stock to own, especially if you don't like large price fluctuations in your portfolio. YCharts lists the 5-year beta ratio for AT&T at 0.75, making it significantly lower in volatility than most stocks. AT&T is less volatile than the S&P 500 index by 25%.
Summing It Up
The primary argument bears have is that AT&T's debt, combined with the seemingly endless cord-cutting trend, dooms those invested in the stock.
While we readily acknowledge the concerns are legitimate, we contend the company's free cash flow, the recent restructuring of debt, and the prospects for HBO Max, will eventually prevail. As noted in the article, we also believe HBO Max provides a badly needed "stickiness" that lowers churn for AT&T's other offerings.
We think the charts below serve to buttress our claims.
Source: Q4 2020 Earnings Presentation
Yes, premium TV losses are a major headwind, but the illustrated data proves AT&T's other businesses are performing well.
We believe AT&T's road to significant growth is unlikely to resume until a larger portion of the company's debt is retired. This will some years be due to the large capex requirements by companies in the telecommunications services industry. However, those same outlays provide AT&T, Verizon, and T-Mobile with a stout moat.
There are those that will object to our lack of attention to developments related to 5G. We will state that I've grappled with the possibilities offered by 5G and cannot come to a conclusion worth conveying to readers.
Despite hours of research, we cannot find definitive proof concerning which company has the superior 5G service. Furthermore, when we peruse statements by the management teams, it is apparent that each predicts significant profits from 5G will not materialize in the short to midterm.
While there are those that sneer at the idea of investing in a stock that will likely provide anemic share appreciation over the short to midterm, I remind investors that the average stock market return over the last ten years is 9.2%.
Additionally, Goldman Sachs forecasts an annualized market return of 6% over the next decade. If Goldman's prognostication is correct, those investing in AT&T at this level will likely do well. They will probably beat the markets given the current dividend of 7%, its annual growth rate.
All considered, we are content with having AT&T as part of our high-yield "model portfolio" that we - and our investment community - rely on to build sustainable income towards our building retirement nest egg.
Also, keep in mind that AT&T is a cheap defensive stock that tends to have lower volatility both during bull and bear markets. Its dividend growth aspect provides a hedge against inflation. For these reasons, we are investors in this high yielder for the very long run and consider it a "buy and hold" forever stock. AT&T remains one of the best SWAN Dividend Aristocrats that retirees can trust.
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This article was written by
Rida Morwa is a former investment and commercial Banker, with over 35 years of experience. He has been advising individual and institutional clients on high-yield investment strategies since 1991.Rida Morwa leads the investing group High Dividend Opportunities where he teams up with some of Seeking Alpha's top income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Lean More.
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.
Treading Softly, Beyond Saving, PendragonY, Preferred Stock Trader, and Chuck Walston all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.
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.