Sunday, October 15, 2017

AT&T: A Telecom Giant On Flash Sale (Part 2)

As of Friday's closing stock price, T is trading at about 23% discount to its fair value of $40 as determined by a P/E of 15 multiplied by its 2017 earnings estimates.

On the downside, historically T has never traded below a P/E of 11 since last recession. Therefore, the P/E of 11 becomes our worst case support for this stock and translates into a risk of additional 9% downside from Friday's stock price.


In this Part 2 article, I will go over the valuation of AT&T's stock (ticker: T) and why I think it is a bargain at the current price. Since I'm writing this article on my Sunday night, I'll be using Friday's closing stock price for all the data and charts. If you missed the first part of this article where I made the case that last week's 6% decline is only temporary and there is more to AT&T than just a telephone company, you can read it here: Part 1

Note that the 8 year historic bottom does not mean that the stock cannot ever go below a P/E of 11, instead it simply tells us that there is enough support built into the stock  (via dividends and earnings) that there is a high confidence that the stock price will not fall through this bottom valuation.

I feel pretty confident about the fair value of $40 as in addition to the 30 Analysts estimates that FastGraphs uses for FV calculation, the MorningStar also has a fair value of $40 for T:

Source: Morningstar.com
MorningStar is maintaining its $40 fair value price on T shares despite AT&T's recent reporting of issues. I think this is because AT&T's management has come out and reaffirmed their full year's guidance.

I bought T stock on Thursday (at the 6% correction) and then some more on Friday as the stock price stabilized. Even if the stock further declines on Monday or even the coming days, I still feel that I got a pretty good deal on one of the blue of the blue chip companies while earning a juicy 5.5% dividend yield.

At the current stock price, T shares are yielding at 5.5% dividend which is higher than its 5 year average yield of 5.30%. So, I am definitely getting a bargain yield.

What about Dividend Health?

Well, let's take a look at how T has paid dividend historically. The two FG charts below shows the last 20 years of dividend history (light green line) as a function of earnings and FCF (Free-Cash-Flow).

You can see that the dividend line has been constantly growing for the past 20 some years, even during the last two recessions. As a matter of fact, during the last two recessions, as the earnings and the FCF plummeted, T continued to not only pay dividends, but even increase it.

Isn't that something? How many companies can afford to increase dividends when the world is falling? This also shows the commitment of T's management towards its shareholders.

T Dividend Growth vs. Earnings (green area)

T Dividend Growth vs. FCF (green area)
Dividend Growth

Some may say, well T has increased its dividend by only 2% since the last recession, so it's not a great dividend growth play and there are other stocks with a much higher dividend growth rate.

That's fair, however don't forget that T has been paying a high dividend around 4.5% for the last eight some years while constantly increasing it. I believe T is the only dividend aristocrat that has payed such a high yield for such a long time.

Would you take a 2% yielder with a 10% dividend growth or a 5.5% yielder with a 2% dividend growth?

Wait! Before you answer, check out the graph below which calculates the dividend return based on the starting yield and the annual dividend growth while re-investing dividends.


Source: https://sugar.mhinvest.com/highcharts/investment.php
As you can see, the company that pays a 2% starting yield (blue line) with a 10% dividend growth, it will take about 26 years to catch up to the dividend income from a company with a 5.5% starting yield (yellow line) and only a 2% dividend growth.

I would take T over a 2% yielder with 10% dividend growth anytime.

What About Debt?

AT&T is essentially a non-regulated utility company that is also trying to be a technology and media company. Though, because of its utility nature, it requires a lot of capital to maintain and repair and upgrade its existing utility infrastructure, similar to what electric utilities do. Therefore, having a high debt is not necessarily a bad thing for a company like AT&T.

Having said that, if you actually compare AT&T's debt to its biggest rival Verizon, you will see AT&T has a far better and stronger balance sheet than Verizon or any of its other competitors. AT&T currently has a 49% Debt/Cap ratio vs. Verizon's 80%.

This is also reflected in the high BBB+ credit rating that AT&T enjoys and growing FCF that easily covers its current dividend payout.

For anyone concerned about T cutting dividends, think about what it will do to the entire Dividend Aristocrat universe. It would be like an earthquake of 8+ magnitude that would wipe out the confidence from the entire aristocrat list.

Therefore, I don't believe for a second that T would even think about cutting its dividend even if they run out of FCF or earnings plunge. They would borrow, sell assets, or do whatever to pay dividend. Though I don't think it will ever get to that.

Closing Thoughts

I don't know what the T shares would do on Monday or the next day or the next week after its earnings report comes out. All I know is that AT&T is a solid company with a very long history of growth and paying dividends. For years, it has been like a staple stock owned by conservative income hungry investors and big institutions and funds who don't mind some growth while earning a stable, safe, and growing income.

I believe the recent dip in the stock price is a great opportunity to invest in this company while getting paid a very nice dividend.

Let me know your thoughts on the T or what I wrote in this article. Thanks as always for reading and commenting.

Disclosure: I am long T and VZ.

Disclaimer: Author of this article is not a licensed/registered financial or investment adviser and does not provide investment advice. Any mention of stock names/tickers in this article or website is not a recommendation to buy or sell. Please do your own due diligence before buying any stocks. This article is for informational and entertainment purposes only. Full disclaimer can be read here: Full Disclaimer

14 comments:

  1. Mr. ATM, Thanks for the detailed analysis. I think it is very insightful. T is one my larger personal holdings, so I will hold and not likely add to the position even though this would be a good entry point as you suggest. I like your analysis of higher current dividend yield/lower dividend growth versus lower current dividend yield/higher dividend growth. That is a relationship I am always trying to balance in my dividend stock portfolio. Tom

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    1. Hi Tom,

      Thank you and yes I understand your reason for not adding more. My current T allocation is about 5.91% of market value, normally I try to stay under 5% for most companies. So, I'm a bit overweight on T right now. But I think that is fine, I do allow myself some flexibility on certain rules when it comes to high quality companies.

      My only other position larger than T is BA (7.53%) and we all know how BA has done this year :)

      All the best,
      Mr. ATM

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    2. Hi Mr. ATM,
      You have been quiet on the blog lately. Hope all is well. I keep coming back to your AT&T analysis here. Have been thinking about adding to my position even though it is one of my larger. Just keep feeling like the market is telling me something with the falling price/rising dividend yield that I am missing. Tom

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    3. Hi Tom,

      Thanks for checking up on me. I've been busy working on my portfolio, mainly some risk management work and figuring out what to buy next. Have been wanting to write about it, but got a bit lazy.

      Regarding T, I know what you mean. Even though I'm quite overweight in T, with the recent price drop, it's very tempting to add more. Though, I will exercise discipline and hold adding more for now.

      But if you haven't bought any T since the recent decline, then it may not hurt to pick a few shares at a very low price and high yield.

      T is under pressure from DOJ on the TWX merger, I still think it will go through, but you never know. DOJ is playing hardball with T management.

      Just listen to your gut and decide how much more you would be comfortable adding, remember risk vs. reward. Maybe do dollar cost average here in small chunks, that’s what I did.

      Take care my friend and thanks again for checking up on me.

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    4. Tom, I just did a quick update post on T to share latest FastGraphs chart with you and other readers. Hope this helps.

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    5. Sounds good Mr. ATM. Glad you have been hunkered down doing your research. I will check out your T update. Tom

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  2. T is one of my larger holdings as well. I bought it a little high though. The bulk of the shares were around $42 when I pulled the trigger. I did buy a few more lower though. I don't think they will cut the dividend either although there is speculation about it supposedly.

    I may add more down the line, we'll see how it goes. Thanks for the detailed analysis. I'm going to share with a friend of mine who has a much larger position in T than I do.

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    1. Hi DS,

      This could be a good opportunity to further average down, but since you already have a full position, you might just wait till next week when T reports its earnings. Who knows, it may further go down or even better if it goes up as that would be a great time to buy after earnings and on a turnaround.

      A dividend raise is also due around 10/23, so keep an eye on that as well if you are concerned about their dividend safety.

      Thanks for reading and commenting,
      Mr. ATM

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  3. We always think of natural disasters effecting the market in certain ways. With the hurricanes I assumed it would really swing the oil stocks prices, which it did. Didn't consider it to effect the Telecom companies. But makes sense, you have extended outage periods, that will hurt revenue so all these companies took a dip. Would love to add more T at these levels but no free capital right now, too bad. Glad you did the comparison and how much time it would actually take to catch up with the growth and yields. T is one of my favorite stocks even though the growth is lower. But it does what we need/ want it to do. Thanks for sharing.

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    1. Daze,

      Always keep some cash on the side to take advantage of such dips. But do not fret, there will always be more opportunities in the market.

      Take care,
      Mr. ATM

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  4. Thanks for sharing, Mr. ATM! I’m always on the lookout for new companies to add to the dividend business. Telecom stocks are another area that my portfolio is lacking in, so I appreciate the tip. I’ve looked at Canadian telecom stocks like Rogers and BCE, but have never really found the right opportunity. T is an absolute behemoth of a company. And I like that you referred to it as an unregulated utility company. That’s a good way of viewing the business. Thanks for sharing your point of view on this undervalued dividend growth stock! Take care🙂

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    1. Hi Graham,

      I looked at BCE while back but haven't recently. Don't think I ever looked at Rogers. I'm just not too familiar with Canadian stocks as I tend to mostly invest in the US based stocks.

      I tend to shy away from foreign stocks due to additional complexity of foreign exchange fluctuations and foreign withholding tax issues. I only own two foreign stocks and they are ENB and ETN. I might add more ENB on dips, but other than that I'm not planning to add any more foreign stocks to my portfolio at this time.

      As for T, I'm happy that I added some on the recent 6% dip as it's not often one gets the opportunity to earn a 5.5% div from a div aristocrat. This is one of those rare occasions when high yield is actually a good yield, that one must not pass!

      Thanks for reading and commenting,
      Mr. ATM

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  5. Hello Mr. ATM,
    Sorry to keep bugging you with my comments, but I've been doing a little blog work this afternoon and I wanted to let you know I added a link to Mr. All Things Money on my "Good Reads" tab at Dividends Diversify. Just thought that anyone that visits my site should definitely check out your content here for your perspectives. Hope this is okay. Let me know if not and otherwise and have a great weekend. Tom

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    1. Hi Tom,

      No problem and thank you for adding my blog to your "Good Reads" tab. I really appreciate it.

      Mr. ATM

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