We believe that current fall in AT&T (NYSE: T) is a good buying opportunity for the investors who want to own dividend stocks. At the current levels, the stock offers an attractive dividend yield of 5.73%. The stock is also likely to show capital appreciation in the long-term. Therefore, we recommend a long position in AT&T at the current levels.
- AT&T’s sharp slide offers an attractive entry opportunity in a dividend aristocrat
- AT&T and Time Warner deal is likely to be delayed, but should go through
- AT&T’s debt is a concern
- For the near to medium-term, the dividend raises should continue
The stock is down about 20% year-to-date. Such a fall, especially in a dividend aristocrat, is because of concerns on the continuation of dividend payouts. Therefore, let’s analyze the stock’s financials and its business to determine whether it’s a value trap or an attractive buying opportunity at the current levels.
Dividend paying history of AT&T
Dividend Aristocrats are companies that have increased payouts for 25 consecutive years. AT&T is part of that distinguished list, as it has increased dividends for 33 straight years. It managed to keep its record intact even during the dotcom bubble and the financial crisis, which gives us confidence. Until the situation turns grim, the company will continue raising its dividend and retain its name in the distinguished list.
Well, if it is such a no brainer, the price of the stock shouldn’t have plunged. There must be certain concerns, which have led the investors to sell the stock. Let’s evaluate them.
The Justice department is opposing the AT&T and Time Warner deal
AT&T operates in a capital-intensive sector where growth has already peaked. Therefore, in order to grow, the companies resort to mergers and acquisitions. In 2015, AT&T completed the purchase of DirecTV – the largest pay TV provider – for about $49 billion. Just a year later, the company agreed to buy Time Warner (NYSE: TWX) for about $85 billion.
The huge content of Time Warner – owner of CNN, HBO and Warner Bros. – and the reach of AT&T has great synergy. The deal was initially expected to close by the end of this year but the Justice Department is opposing the deal. Therefore, AT&T’s chief financial officer, John Stephens said during a recent investor conference that “the timing of the closing of the deal is now uncertain.”
Nevertheless, the executives of the two companies are unlikely to give up without a fight, as they believe that the Justice Department doesn’t have the legal grounds to deny this deal. The final outcome is likely to be decided in the court of law.
Huge debt even if Time Warner deal is approved
Unless AT&T invests to upgrade its business, or acquire companies, which have a good synergy, it will not be able to compete and stay ahead of its competitors. Hence, the investors don’t expect the company to remain debt free. However, the debt should not be unserviceable, endangering future dividend payouts.
The current debt to EBITDA of AT&T is 2.19 times. On completion of the Time Warner acquisition, the debt/EBITDA is likely to increase to 2.8 to 3 times. The management wants to bring down the debt level, as soon as possible. This casts a doubt over the continued dividend raises. Will the company sacrifice the dividend for debt repayment?
AT&T has been cash flow positive for more than a decade. Companies pay out dividends from their free cash flows. The payout ratio has mostly ranged between 52 to 70% with the odd spike to 94% in 2014.
This year, the company generated a free cash flow of $12.8 billion in the first three quarters and paid out a dividend of $9 billion, resulting in a payout ratio of 70.5%. The management has maintained its guidance for 2017 and is likely to end the year with a free cash flow of $18 billion.
On the other hand, Time Warner has generated a free cash flow of $3.57 billion in the first three quarters of this year. In 2016, the company had earned a free cash flow of $4.25 billion. Let’s consider a conservative estimate and expect the company to earn only as much as last year.
If the deal receives the green signal before the end of the year – though highly unlikely – the combined entity will end the year with a free cash flow of $22.25 billion.
After the merger, due to the equity dilution, AT&T’s dividend liability will increase to $14.5 billion.
For the nine months ended September 30, the company paid an interest of $4.3 billion. So, for the whole year, the company may end up with about $6 billion in interest expense. Add the additional $1.3 billion, which AT&T has to bear on assuming new debt following the Time Warner deal and the total comes to $7.3 billion.
Adding the interest expense and the dividend payout, we get a figure of about $21.8 billion. This doesn’t leave the company with enough money to allocate for debt reduction.
However, the figure also doesn’t put the dividend in danger, as it can easily be accomodated in the free cash flow. But, is there a danger that AT&T’s free cash flows will decline in the short-term or the medium-term?
Financial performance of AT&T
|Revenue in billions||127.43||128.75||132.45||146.8||163.79|
|EBITDA in billions||31.14||48.87||32.14||46.65||51.72|
From the above figures, we find that AT&T has been able to gradually increase its revenues for the past five years. Similarly, the EBITDA has been on a gradual uptrend, which shows that the company has been able to maintain its profitability.
How has the company performed this year?
The company has so far maintained a flat performance in 2017.
In the third quarter of this year, the company’s revenues fell from $40.9 billion in 2016 to $39.7 billion. Similarly, the reported earnings per share (EPS) also fell from $0.54 to $0.49, which shows a marginal slowdown.
While the result is not something to write home about, it is not an outright disaster as well.
According to Nasdaq.com, the analysts forecast a long-term growth rate of 4.8%. The consensus 12-month price target is $40, which is a good 17% above the current price of the stock.
With the likelihood of the small dividend raise intact and a possibility of price appreciation, let’s see what does the chart point to.
What does the chart forecast?
The stock had been forming a large ascending triangle pattern. However, three weeks back, the stock broke below the strong trendline support, which is a bearish sign. Nevertheless, the stock has a strong support at the $32, which has not been broken on a weekly closing basis since mid-2012.
On the upside, the trendline, which had been acting as a strong support until now is likely to act as a stiff resistance. However, In the long-term, if the stock climbs above the trendline at $36, a move to $40 and thereafter to $43 is possible.
If interest rates rise quickly, AT&T’s interest expenses will rise. Additionally, if the company is unable to stay ahead of the competition, its free cash flows will decline and the dividend payouts will be in danger.
However, this is unlikely to happen within a single quarter. We shall continue to track the stock and its financials.
In order to track our investments better, we shall maintain active portfolios for dividend and growth. This will help us compare our performance with the markets.
In that step, we shall include AT&T as the first stock in the dividend portfolio at the current levels of $34.22.
Featured image courtesy of Shutterstock.