Bob Ciura, contributing editor at Sure Dividend, offers a deep dive into AT&T (T) and the recent spin-off of its media operations — and how AT&T shareholders should position themselves moving forward.

Telecom giant AT&T Inc. has long been a reliable dividend holding for income investors. AT&T has typically offered a high dividend yield well above the market average. And prior to its spinoff announcement and recent dividend reduction, AT&T was a Dividend Aristocrat thanks to its 30+ years of rising dividends.

The company made a huge move on May 17th, 2021 when it announced an agreement to combine WarnerMedia with Discovery to create a new global entertainment company; the transaction officially closed on April 8th, and the new company is called Warner Bros. Discovery, Inc. (WBD).

Conceivably, AT&T’s renewed focus on its telecommunications businesses is an attempt to return to growth. By separating its media businesses, AT&T intends to refocus on its core competencies, without the burden of having to invest in wireless network infrastructure and media assets at the same time.

Nevertheless, there are significant implications for AT&T shareholders, particularly for income investors. AT&T was having some difficulty growing its dividend after the Time Warner acquisition. In fact, the company had not raised its per-share dividend since December 2019. A revised dividend of $1.11/share equals a current dividend yield of 5.6%.

AT&T is clearly using the spinoff as an ‘opportunity’ to reduce its dividend obligation to shareholders going forward. This is being done in order to have more funds to invest in future growth prospects.

While income investors never want to see one of their stock holdings cut its dividend, particularly a former Dividend Aristocrat such as AT&T, there are reasons for shareholders to be optimistic. The new AT&T is going to be simplified, with a renewed focus on the core telecommunications businesses that made AT&T into the industry giant it is today.

This also means AT&T will have an improved financial position with less debt. Investors should keep in mind that paying down debt has been a financial priority for AT&T in the past several years. The mega-merger with Discovery is not the only deal AT&T has made; the company previously announced a number of asset sales and other moves, all with the goal of deleveraging.

While AT&T’s dividend reduction will be a negative for shareholders in the short-term, it could pave the way for a return to dividend growth down the road by further reducing debt and focusing the company on its core competencies.

AT&T is forecasting 4.5% earnings-per-share growth from fiscal 2022 to fiscal 2023. Over the next 5 years, we believe a modest 2% annual earnings-per-share growth expectation for AT&T is both prudent and conservative. This growth estimate may well prove to be too low; there’s certainly room for an upward surprise.

With a post-transaction share price of $19.63, and expected EPS in fiscal 2022 of $2.44 at the midpoint of guidance, this implies a forward price-to-earnings ratio of just 8.0.

This appears to be far too low for the company. We believe a price-to-earnings ratio of 10 is a reasonable semblance of fair value. This implies ~25% upside from current prices.  If the valuation multiple were to drift upwards over the next 5 years from 8 to 10, this would generate annualized returns of ~4.6% annually.

With a 5.6% dividend yield using the new dividend, 2% expected growth returns, and 4.6% returns from valuation multiple expansion, we expect total returns of around 12.2% annually from AT&T over the next 5 years.

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