Better High Yield Telecom Buy: AT&T Stock Or Lumen Technologies Stock

Apr. 25, 2022 11:15 AM ETLumen Technologies, Inc. (LUMN), TT.PA, T.PC, TBB, TBC54 Comments38 Likes

Summary

  • LUMN and T offer extremely appetizing passive income yields.
  • Both businesses have faced considerable challenges in recent years but seem to be turning the corner.
  • We look at their respective valuations to determine which is the better buy right now.
  • Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our model portfolio. Learn More »

Passive income inscription on the board and a bundle of bills.

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For investors looking for a passive income boost, two attractive options at the moment are Lumen Technologies, Inc. (NYSE:LUMN) and AT&T Inc. (NYSE:T). Both businesses have faced considerable challenges in recent years, with LUMN's revenue steadily declining and T's overleveraged and underperforming acquisitions forcing the company to slash its dividend and spin off the media business in an attempt to deleverage and simplify the business.

However, both businesses look to be turning a corner, with LUMN shedding non-core assets in two multi-billion dollar asset sales this year and guiding for a return to topline growth no later than the end of 2023. T also looks poised to make substantial progress towards deleveraging its balance sheet, and its dividend is now on a much firmer footing following the recent cut. As a result, both stocks look increasingly appetizing as potential sources of high yield passive income

In this article, we take a look at both stocks to determine which is the better buy right now.

#1. T Stock: Attractive & Safe Dividend But Weak Upside Potential

After licking its wounds for massively overpaying for the T/Time Warner merger, T has finally spun off those assets along with a sizable chunk of debt. With the dividend right-sized and a simplified business model, T looks poised for better times ahead.

It is now a pure-play telecommunications giant with a clearer focus on making the investments needed to strengthen its competitive positioning in an industry that requires substantial capital investments. In fact, management has announced that it plans to invest at "record levels" in 5G and fiber in an effort to become "America's best broadband company." The company also announced that it will simultaneously be focused on paying down debt further.

With a $1.11 dividend, the stock currently yields an attractive 5.7%, with a 43% earnings payout ratio and a 46.4% free cash flow payout ratio forecast for 2022. When combined with the leaner balance sheet thanks to spinning off a lot of debt in the recent media transaction, T's dividend looks very safe.

While this looks great for the dividend investor, there are some downsides here. First of all, T still has a ways to go to meet its deleveraging plans and also needs to invest aggressively in fiber and other projects to help strengthen its core businesses. As a result, it is unlikely that it will be able to put much - if anything - into growing its dividend for the foreseeable future. In fact, analysts expect the dividend to remain $1.11 per share in 2023 and only stand at $1.12 in 2025.

A second downside here is that the valuation does not look particularly appealing. While the P/E and P/FCF ratios look attractive relative to recent history (P/E of 7.79x compared to its 5-year average of 9.74x and its P/FCF is 7.10x compared to its 5-year average of 9.26x), its EV/EBITDA ratio remains elevated relative to T's recent and long-term history (EV/EBITDA ratio is 8.23x compared to its 5-year average of 7.16x and historical average of 6.34x).

Furthermore, T's growth potential looks very anemic for the foreseeable future, as analysts forecast a measly 1.3% earnings per share CAGR through 2026. When also considering that interest rates are poised to continue rising, this means that the dividend is pretty much all that investors should expect to receive in total returns from this stock at current prices.

That said, the investment thesis has been largely de-risked thanks to the dividend cut and the spin-off of the media business, so T remains a very safe high yield pick that faces very little risk of a further dividend cut from here. We view it as a Hold accordingly.

#2. LUMN Stock: Risky Sky-High Yield But Substantial Upside Potential

Unlike T, LUMN's dividend is on a much riskier footing. For one, it lacks an investment-grade credit rating which - in a rising interest rate environment - could put the dividend, especially at risk. Furthermore, the dividend payout ratio is expected to be 75.8% of earnings in 2022 and 102% of earnings in 2023.

That said, the free cash flow payout ratio - a more important payout ratio metric in our view - looks a bit better, forecast to be 56.5% in 2022. Furthermore, LUMN's debt maturity ladder looks quite good for the foreseeable future, especially once the company closes its asset sales later this year and pays down billions of dollars of debt with the proceeds. In fact, the company stated on its recent earnings call:

[A]bout 80% of our debt is fixed. If you combine that with the fact that we refinanced about $20-plus billion in the last three years and the fact that we are going to be paying down a significant amount of debt [following closing these sales], and you look at our maturity profile, we have very minimal needs in terms of tapping the market. So, I think we are very well-positioned in terms of our balance sheet...

I think we have been pretty good about calibrating our leverage to the business profile. So even though we are divesting a fair amount of legacy revenues, we haven't really levered up. If you think about Quantum Fiber, that's going to be a high-growth business and infrastructure business. So, you always have to think about de-averaging our leverage and think about whether that's appropriate going forward. Our view right now is the 3.6 is probably a good assumption.

Now we have said that it will be roughly in that zip code. So, any quarter-over-quarter, you might see some fluctuations. But until the business profile changes significantly, we don't see the need to change that at this point. And like Jeff has mentioned several times is we are going through an investment cycle, and it truly is a discrete project. It is upgrading our copper network to fiber and it's a long-lived asset. And so, as we do that, we are okay with the leverage fluctuating a little bit as we fund that build.

While it looks like the balance sheet is on firm enough footing and free cash flow generation will be sufficient enough for the foreseeable future to support the dividend at current levels, the dividend's viability beyond 2022 and especially 2023 depends upon how effectively LUMN is in generating topline growth.

Management has guided for topline growth to return by the end of 2023, but with inflation rising, the company may not be able to get as much bang for its CapEx dollars as it had originally forecast. If it wants to maintain its dividend at current levels, it might have to reduce its growth investment ambitions.

The other option LUMN has is to sell off more of its lower-tier/non-core assets and reinvest the proceeds in deleveraging and buying back stock. This could help to shore up the balance sheet by further lengthening the debt maturity schedule and also support the dividend by reducing the total dividend payout burden by reducing shares outstanding at a current yield of 9.25%.

Best of all, such a course of action would undoubtedly unlock value for shareholders given that the EV/EBITDA ratio is 6.28x, which is well below where LUMN could likely sell its remaining assets.

Investor Takeaway: LUMN Is A Strong Buy

Due to the fact that LUMN actually trades at a cheap valuation (16.3% free cash flow yield, 9.25% dividend yield, and a 6.28x EV/EBITDA multiple), we view it as a Strong Buy, though certainly not a low-risk investment.

In contrast, we view T as a much lower risk investment than LUMN that should provide sleep-well-at-night dividend income moving forward. However, it offers very little to no upside potential and also has very weak growth potential.

The key to the LUMN thesis will be how management unlocks the deep value embedded in the shares. They can do so by either returning to top-line growth, selling off assets further and then buying back undervalued shares, or some combination of the two. While management, for now, is saying that returning to top-line growth is their top priority, with inflationary and competitive pressures increasing, selling off assets - if not the entire company - might be the best bet at this point. Time will tell, but we believe that the deep value presented in the shares warrants a Strong Buy rating for LUMN. That said, due to the uncertainty here, we are keeping our position fairly small.

T, in contrast, offers little that excites us beyond the dividend yield, and in the current market, we are finding much more interesting opportunities with similarly safe 5.5%-6% dividend yields.

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This article was written by

Samuel Smith profile picture
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Samuel Smith is Vice President at Leonberg Capital and manages the High Yield Investor Seeking Alpha Marketplace Service.


Samuel is a Professional Engineer and Project Management Professional by training and holds a B.S. in Civil Engineering and Mathematics from the United States Military Academy at West Point. He is a former Army officer, land development project engineer, and lead investment analyst at Sure Dividend.

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Disclosure: I/we have a beneficial long position in the shares of LUMN either through stock ownership, options, or other derivatives. 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.

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