AT&T (T): An Out Of Favor Dividend Aristocrat With a 7% Yield

Last Updated on June 20, 2023 by Josh Arnold

Dividend stocks, like AT&T (T), which is a Dividend Aristocrat, have been somewhat out of favor in the broader market rally that has occurred in the past several months. Growth stocks have led the way higher, and while that means holders of dividend stocks may have missed out on the biggest gains from a price perspective, it also means there is value in a variety of places.

One such stock that is showing a lot of value for dividend investors today is communications and entertainment giant AT&T (T), a long-time dividend stock favorite. AT&T has traded sideways for the bulk of 2020, following a sharp decline with the broader market earlier this year. However, this has created a situation where the valuation and yield look quite favorable.

Given that AT&T is a Dividend Aristocrat, meaning it has at least 25 years of consecutive dividend increases, its 7% yield and low valuation are all the more attractive. AT&T is also a Dividend Champion.

Business Overview of AT&T

AT&T traces its roots all the way back to the late-1800’s when Alexander Graham Bell invented the first telephone. AT&T has gone through significant M&A in the past century-plus, with the most recent version being the product of a merger between the former SBC Communications and the prior version of AT&T Corp.

Today, the company is the largest communications company globally, with a diverse suite of communications and entertainment businesses, including the WarnerMedia business, as well as cable TV, internet, and wireless phone services, among others. AT&T has a market capitalization of $208 billion and should generate about $169 billion in revenue this year.

AT&T reported second quarter earnings on July 23^rd, with results coming in largely in line with expectations. Revenue was $41 billion, down from $45 billion in the year-ago period. Management said the decline was due to COVID-19 impacting all of its operating segments.

Adjusted earnings-per-share came to 83 cents, which was down from 89 cents in the same period last year. The company estimates three cents of negative impact from incremental costs from COVID-19, as well as a further six cents from lower revenue. Adjusted for these items, earnings would have been in line with last year’s second quarter.

The WarnerMedia segment launched the highly-anticipated HBO Max during the second quarter, and AT&T generated nearly $8 billion in free cash flow despite the unique challenges present during the quarter.

The company withdrew prior guidance due to the unforeseen impacts of the coronavirus pandemic, and we now expect $3.25 in earnings-per-share for 2020. This would be the lowest earnings-per-share for AT&T since 2017, although we expect earnings to rebound in 2021 and beyond as the impacts of the pandemic gradually subside.

Growth Prospects of AT&T

We see AT&T as having a handful of ways it can boost its earnings-per-share in the coming years. The company has been very busy acquiring businesses in the past, such as Warner and DirecTV, amongst others. This helps grow the top line, as well as providing scale for back office support costs.

In addition, AT&T is reducing labor costs, which is a new effort as of a couple of months ago. It is also optimizing its retail network and its real estate – including its sale of its Hudson Yards property – and looking at further corporate cost reductions. AT&T has operated with excess support capacity for years as it has worked to integrate large acquisitions, rather than focusing on costs. Now that it is well into the Warner acquisition, these rationalizations are a necessary and beneficial step to undertake.

Apart from cost savings, AT&T is innovating with its Warner properties, the best of which is HBO.

AT&T has launched HBO Max with good success, as the HBO suite has about 36 million subscribers. The company is also busy cross-selling its Warner properties with its legacy services, which should result in higher engagement per customer over time for the consolidated company.

Overall, we see three percent annual growth in the coming years as our estimates have moved down slightly thanks to the pandemic. We think AT&T has some work to do, but that it can return to growth with the combination of its revenue and cost saving initiatives.

Dividend and Valuation Analysis for AT&T, An Out of Favor Dividend Aristocrat

Investors are obviously quite interested in AT&T’s dividend given its Dividend Aristocrat status, and because utilities like AT&T are generally held for their income potential. At the current price of less than $30, AT&T’s income potential is sizable with its 7.1% current yield.

AT&T has committed to raising its payout for the foreseeable future, and given that we forecast a payout ratio of 64% on this year’s lowered earnings per share estimate of $3.25, there should be plenty of room to do so. We recognize that AT&T still has an enormous amount of debt and a somewhat uncertain earnings outlook for 2020. However, we also note this business has stood the test of time and we don’t believe its 36-year streak of dividend increases is at risk. The chart below from TIKR* shows the dividend payout, annual growth rate, and payout ratio over the past decade.

Shares trade today at just nine times our estimate of 2020 earnings as the stock has been relatively weak in the past few months. We assess fair value at 12 times earnings, meaning AT&T looks quite undervalued today. In fact, we expect a 6% annual tailwind to total returns in the next five years from the valuation alone. AT&T is being priced as though its business is in perpetual decline, which we do not believe to be the case.

Final Thoughts on AT&T, An Out of Favor Dividend Aristocrat

AT&T has its challenges, not the least of which is its high leverage, despite recent efforts to reduce outstanding debt. However, we think the company’s plan to grow revenue and reduce costs simultaneously will result in a return to normal earnings next year and beyond, and that its dividend will continue to grow for many years.

With a 7%+ yield, a sizable tailwind from the valuation, and modest earnings growth, we expect AT&T to produce 14% total annual returns in the coming years. With an attractive total return profile like that, we rate the out of favor Dividend Aristocrat, AT&T, a buy.

Disclosure: Members of the Sure Dividend team are long AT&T.

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