AT&T Offers A Fat Dividend, But You’re Paying For It Yourself (NYSE:T)

Even Benjamin Graham preferred AT&T for its dividend

I’ve had belief points with dividend shares since AT&T (NYSE:NYSE:T) slashed their dividend within the wake of the Warner Bros. (NASDAQ:WBD) spin-off. I bought my shares shortly thereafter. I’m glad I did, as a result of the inventory value has gone nowhere however down since then, consistent with the 5 YR and 10 YR development.

Now the nice factor is now you can purchase the shares and get just about the identical dividend as you might earlier than the spin-off.

Shopping for AT&T for its dividend can be no new phenomenon. Based on Alice Shroeder’s biography on Warren Buffett (“The Snowball”), at one level in his lengthy investing profession, Benjamin Graham began shopping for shares of AT&T. This transfer puzzled Warren Buffett, then Graham’s apprentice. Graham had at all times purchased the “cigar butt” kind firms nobody else needed – not blue chips like AT&T. It turned out Graham was about to retire and had purchased AT&T to protect his capital and obtain the dividends. This was within the Fifties.

Greater than 70 years later, many buyers are nonetheless contemplating AT&T a protected haven blue chip with a robust dividend. Nonetheless, this popularity is below stress, and in 2022 AT&T misplaced its “Dividend Aristocrat” standing. This in fact leaves the query whether or not AT&T can flip issues round and as soon as once more set up itself as a number one dividend inventory. As I will probably be discussing intimately beneath, I’ve my doubts: The corporate struggles to develop high and backside strains with debt weighing on its stability sheet, and even after analyzing future prospects, I’m left on the bearish facet.

For this reason I feel you are paying for the dividend your self

AT&T has vastly extra long-term debt sitting on its stability sheet now than it did 10 years in the past. AT&T solely began lowering its debt load in 2020-2021, and has been in a position to proceed paying down the debt since then – partially by means of the spin-off of WBD (numbers from Searching for Alpha):

Yr 2014 2015 2016 2017 2018 2019 2020 2021 2022 TTM Debt (USD, ~billions) 77 122 118 128 167 149 152 150 133 128 Click on to enlarge

The current concentrate on repaying debt does not cover the truth that the face worth of AT&T’s debt is greater than the entire fairness tranche of AT&T’s capitalization at the moment priced at roughly $100 billion. It additionally does not cover the truth that AT&T has struggled to convey down the entire curiosity expense whatever the decrease debt (numbers from Searching for Alpha):

Yr 2014 2015 2016 2017 2018 2019 2020 2021 2022 TTM

Curiosity (USD tens of millions)

3,613 4,120 4,910 6,300 7,957 8,422 7,727 6,716 6,108 6,296 Click on to enlarge

A lot of AT&T’s debt was taken on to fund acquisitions, the most important of which had been the acquisition of DirecTV in 2015 and Time Warner in 2018. DirecTV has later been exited partly at nice expense to shareholders, not least as a result of the income and earnings from that division is now gone whereas the debt from the transaction remains to be there. The identical holds true for Time Warner which turned a separate firm in 2022.

Including to that is the truth that AT&T has regularly elevated its shares excellent. When the variety of shares excellent is elevated, remaining shareholders personal a comparatively smaller a part of the belongings of the corporate. With the mixture of shares excellent growing and debt having elevated over time, you are sharing the pie with increasingly different buyers (numbers from Searching for Alpha):

Yr 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Shares (~billions)

5.2 5.6 6.2 6.2 6.8 7.3 7.2 7.2 7.2 7.2 Click on to enlarge

It must be famous, nonetheless, that if not rounded the shares excellent is now barely decrease than it was in 2020.

So whilst you’re getting a dividend cheque each quarter, you are additionally seeing a regularly growing fairness and debt declare in opposition to the belongings that you just personal a residual share of. Think about you probably did this together with your private funds. You’re taking out a mortgage from a financial institution merely to pay your self a quarterly quantity with cash from that mortgage, otherwise you dilute your curiosity in an asset by permitting in additional co-owners on a regular basis. Would this make you higher off financially?

I assume issuing shares and taking over extra debt can be affordable if the corporate was rising. A minimum of then they’d have extra cash to service the stakeholders. However revenues are principally flat measured in opposition to that of 10 years in the past. A few of that’s attributable to sell-offs and write-downs. However the debt remains to be there, and so are the brand new equities issued. That is the event of AT&T’s income (numbers from Searching for Alpha):

Yr 2014 2015 2016 2017 2018 2019 2020 2021 2022 TTM Income (USD ~billions) 133 147 164 161 171 181 143 134 121 121 Click on to enlarge

As famous, AT&T’s internet earnings has additionally decreased lately and are at the moment within the adverse. A lot of that is attributable to write-downs and different accounting strategies. The desk beneath illustrates the event (numbers from Searching for Alpha):

Yr 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Internet earnings (USD ~billions) 6.4 13.4 13.0 29.5 19.4 13.9 (5.2) 20.1 (8.5) (8.8) Click on to enlarge

In my view, with a basic development of diluting shareholders by means of issuing shares, and a development to borrow and thereby tying belongings to loans and committing to curiosity funds – with out development following from that – as a shareholder you’ve got principally let your belongings lose worth in alternate for receiving a money dividend.

Even with the unfavourable developments that I’ve highlighted right here, it’s apparent that AT&T’s place as a high wi-fi provider and different belongings make AT&T nonetheless a really precious firm.

Going ahead, AT&T must try to reverse the scenario. For the upcoming quarter – to be reported in a few days – the income estimate is $30.24 billion. This, nonetheless, may be very a lot consistent with what AT&T turned over per quarter earlier than the DirecTV acquisition, which was additionally round $30 billion 1 / 4:

A lot of AT&T’s income development within the years 2016-2019 was because of the DirecTV acquisition. Earlier than that and after the spin-off, AT&T’s “old-school” core enterprise areas corresponding to mobile phone service and broadband have needed to drive the income development. However going ahead, I do not see these areas instantly delivering extra development than they’ve been for years. Subsequently, I’d count on AT&T’s income to develop positively within the low single-digits over the approaching years. As soon as AT&T will get all of the accounting friction from DirecTV and Time Warner (write-downs and so forth.) out of the way in which, I’d count on internet earnings to observe go well with and in addition develop within the low single-digits – no less than when assessed over a multi-year interval. One factor that I will probably be following with specific curiosity within the years forward is whether or not AT&T will as soon as once more try to purchase their approach into rising. They’ve struggled to take action prior to now as demonstrated by the acquisitions talked about right here. Nevertheless it’s one basic option to try and push development for firms that generate masses of cash however can not seem to develop the core enterprise.

Within the following, I’ll try and assess what the developments outlined right here imply for the worth of the inventory.

The worth of AT&T shares

AT&T at the moment trades at a ahead P/E of ~6.

This seems a low earnings a number of, however for those who settle for the premise that AT&T is usually purchased for its dividend, then justifying even that value goes to require some development within the dividend.

To reach at a good value estimate for AT&T, I will use the “H-Mannequin” variant of the dividend low cost mannequin (DDM). The H-Mannequin is used to estimate the current worth of future dividends. In contrast to the basic DDM, it assumes an preliminary stage of excessive dividend development, and a subsequent stage of low development.

For the excessive development stage, I assume dividend development of 1 % a 12 months. That is not lots, however AT&T hasn’t grown its dividend in any respect not too long ago with a purpose to focus its huge free money stream technology (greater than $12 billion for 2022) on debt compensation. For the needs of this evaluation, I assume that this excessive stage is 5 years. For the low development stage, I am assuming a perpetual 0.5 % dividend improve. The required fee of return is about at 9 %, considerably consistent with the overall market.

Below these assumptions, every share of AT&T ought to commerce at $13.29, or a ahead P/E of ~5.5. That is a lot consistent with the present share value, albeit barely decrease, suggesting modest overvaluation.

How I may very well be mistaken

The funding thesis laid out right here requires warning with the AT&T inventory due to its development bother and the rise in debt and fairness. Shopping for a inventory for its dividend when development lacks and debt and fairness are elevated appears a poor technique to me.

Having mentioned that, there’s “threat” in that thesis within the sense that it may very well be mistaken for quite a lot of causes.

To start with, there’s the worth. The ahead P/E of AT&T is lower than 6. Even for a no-growth firm, that is very low. With a price ticket like that, it is attainable that even below stress, the corporate may very well be undervalued. If AT&T begins really rising its high and backside line sustainably, the inventory is clearly undervalued as nearly no development seems priced in. I simply doubt it’s going to develop a lot on a per share foundation.

Secondly, AT&T clearly has a moat within the telecommunications sector. It is laborious to think about anybody actually succeeding in taking over the few firms dominating phone communications – AT&T, Verizon (NYSE:VZ) (which, by the way in which, is a former AT&T group firm) and T-Cell (NASDAQ:TMUS). Additionally, inside broadband and fiber companies, AT&T has an equally sturdy place. AT&T even managed to outcompete Google when Google entered the fiber market solely to pause growth shortly thereafter. AT&T merely lowered costs and upped their choices.

The mixture of a low P/E (low to no development expectations) and powerful positions in its market might make AT&T a standard worth inventory – or a price lure, relying very a lot on the event within the years forward.

Key takeaways

AT&T is a widely known dividend inventory that has been well-known for its dividend for many years. It not too long ago misplaced its “Dividend Aristocrat” standing because it did not hold growing dividends within the wake of the WBD spin-off and its elevated concentrate on repaying debt.

It seems the dividend might nonetheless be below stress in coming years. AT&T has regularly elevated its shares excellent, and debt hundreds – though lowering – are appreciable. AT&T has had a tough time pushing down the extent of curiosity bills. The mixture of dilution from issuing shares and the truth that AT&T has taken on vital debt with out rising high and backside strains because of this make me conclude that as a shareholder, you are principally paying the dividends your self by means of the relative improve in claims in opposition to the belongings you residually personal as a shareholder.

Assessing the inventory worth utilizing the H-Mannequin (modified DDM) confirms this assumption. With little to no development, the inventory seems barely overvalued by the market as I’ve estimated a good value at simply above $13 per share.

In fact, on an absolute foundation, a P/E of ~6 is comparatively low. With nearly no development priced in, I may very well be confirmed mistaken if AT&T begins persistently rising high and backside strains.

However even with AT&T’s sturdy place in its core markets, I feel AT&T has an excessive amount of debt and too little confirmed development to be a worthwhile funding at this level.

For the explanations said above, I fee AT&T a Promote.