Ben Reynolds — editor of Sure Dividend — continues his review of his top five Dividend Aristocrats — selected from among those stocks in the S&P 500 Index that have each increased their dividends for 25 years in a row or longer.
Investors tend to think of telecom stocks as stodgy, slow-growth investments. While they are not very exciting to own, the top telecom stocks have provided years of low volatility and high dividend payouts to shareholders.
Read Part 1 of this special report here.
Read Part 2 of this special report here.
More from Ben Reynolds: Dividend Aristocrats Part 2: AbbVie
AT&T (T) qualifies as such, with a high yield above 6% and over 30 years of annual dividend increases under its belt. But this Dividend Aristocrat is shaking things up in a big way. After multiple large acquisitions in the past decade to expand its business model into new areas, AT&T is returning to its core. This article will discuss AT&T’s recent moves and how shareholders should view the stock moving forward.
AT&T’s Major Unwind
Under the leadership of former CEO and Chairman Randall Stephenson, who retired in April 2020, AT&T made two huge deals: the $49 billion takeover of DIRECTV in 2015, and the $85 billion acquisition of Time Warner in 2018. Both deals were made with the goal of broadening AT&T’s business model beyond the traditional telecom services like wireless and Internet. These deals gave AT&T exposure to satellite TV and ownership of media content.
At the time the deals were made, AT&T was confident in its ability to fold in these new services into one umbrella, allowing the company to offer better packages than competing telecoms.
Meanwhile, AT&T believed it could generate billions in cost savings through operational synergies, which was important to help pay down the enormous pile of debt AT&T had accrued to finance the acquisitions. On that note, AT&T ended 2018 with more than $166 billion in long-term debt on its balance sheet, up from $76 billion at the end of 2014.
What AT&T soon realized was that it had grown too large to accomplish all of its objectives. In the traditional telecom space, AT&T fell further behind close rival Verizon Communications (VZ) for the #1 spot in wireless, and in 2020 ceded the #2 position in total branded customers to T-Mobile (TMUS).
In television, AT&T struggled to generate the growth it anticipated from DIRECTV as satellite television faded into obsolescence.
While media still has growth potential, AT&T quickly realized it had become a victim of what Peter Lynch famously referred to as “diworsification”, which refers to a company that expands its business model too much and eventually loses its competitive advantages.
Today, AT&T is working aggressively to unwind the multiple acquisitions that took years, and tens of billions of dollars to materialize. First, in February AT&T announced it would spin off a separate company called New DIRECTV that will own the DirecTV satellite TV business, as well as AT&T TV and U-verse video. AT&T sold 30% ownership to TPG for approximately $8 billion, which was used to pay down debt.
Then, in May the company announced it would fold its media assets including Time Warner into a merger with Discovery Inc. (DISCA) to create a new global entertainment company. AT&T will receive $43 billion in a combination of cash, securities and retention of debt. AT&T shareholders will own 71% of the new company, while Discovery shareholders will own the remaining 29%.
The company will combine HBO Max and Discovery+ to compete in the direct-to-consumer business, bringing together various properties including HBO, Warner Bros., Discovery, CNN, HGTV, Food Network, TNT, TBS and more. The transaction is expected to close by the middle of next year, and the new company is expected to generate annual revenue of $52 billion.
Why The Road Ahead May Be Easier For AT&T
The past few years have not been kind to AT&T shareholders. The stock performance has significantly lagged the market, even when including AT&T’s generous dividend payouts. For example, in the past five years AT&T stock delivered an annualized return of just 0.90% including dividends.
In the same period, the major ETF that tracks the S&P 500 Index, under the symbol SPY, had total returns above 17% per year. AT&T has badly underperformed, in large part because of its mountain of debt and inability to generate growth.
But while the recent past has been difficult, the future may be much better for AT&T investors. After the DIRECTV and Time Warner transactions are complete, AT&T will be able to return to its core telecommunications focus. This is increasingly important as the major U.S. wireless carriers race to build their 5G capabilities.
Indeed, AT&T expects the remaining businesses to generate low single-digit revenue growth, along with mid-single digit growth in its adjusted earnings-per-share. As a result, AT&T may finally be able to reignite the growth that has eluded it over the past several years.
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One potential negative outcome is that AT&T will likely reduce its dividend. Along with the announcement of its asset merger with Discovery, AT&T stated it would declare a resized dividend equaling 40% to 43% of the free cash flow generated by the new AT&T.
With expected annual free cash flow above $20 billion, this works out to an implied dividend payout of $8 billion, or roughly $1.15 per share based on the current shares outstanding. At a recent share price of ~$30, this means AT&T would yield just under 4% once the revised dividend payout is declared.
While investors never want to see a dividend reduction, on the other hand it means AT&T will be freed up to continue its debt pay down and reinvest in the growth initiatives most important to the company, such as its 5G network. We reiterate our forecast of 3% annual adjusted EPS growth for AT&T over the next five years. Dividends, even at a reduced level, will also contribute positively towards shareholder returns.
Finally, we view the stock as undervalued, as the divestments will allow AT&T to become more efficient. We maintain a fair value price target of $35 per share for AT&T.
The past few years have been challenging for AT&T and its shareholders, as the M&A spree the company embarked on did not produce the anticipated results. AT&T is now attempting to unwind those mega-deals. However, we believe the spin-off could unlock greater value than the current company holds.
Therefore, the recent sell-off in AT&T stock after the merger announcement is a potential buying opportunity. The stock appears undervalued, while the company could see renewed growth and should continue to pay a competitive dividend. With expected returns above 10% per year, AT&T is one of our top-ranked Dividend Aristocrats.
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