Today we conclude a special 3-part feature from dividend specialist Ben Reynolds, the editor of Sure Dividend, and his review of the 3 highest-yielding stocks among the 53 Dividend Aristocrats — stocks which have raised their dividends every year for the past 25 year.
In Part 1 of this feature we looked at AbbVie, with a yield of 3.92%. In Part 2, we looked at Exxon Mobil (XOM), yielding 4.2%. We now look at the highest yielding Dividend Aristocrat — AT&T (T), with a 6.0% yield. (For disclosure, Ben Reynolds is long AbbVie, Exxon Mobil and AT&T.)
AT&T is a leading provider of communications and digital entertainment services in the United States and the world, offering internet access, as well as TV and wireless service. The company is the result of a dizzying array of mergers since it was spun off in 1984 and today, it sports a market cap of $222 billion.
AT&T reported Q2 earnings on July 25th and investors sold the stock on the news. Revenue fell by about 3%, but adjusted earnings-per-share rose 15%. The company added 3.8 million new wireless subscribers, 3.1 million of which were in the US, driven by strength in prepaid. Postpaid churn remained low at 0.82% and new net postpaid subscribers totaled 46,000.
DirecTV NOW continued its torrid pace of growth, adding 342,000 new subscribers and hitting 1.8 million total, just a few quarters after its initial launch. The Time Warner acquisition closed just prior to the end of the quarter and results were strong there as well.
HBO and Turner saw subscription growth and the latter’s ad revenue was up 3% in Q2. Free cash flow was up 46% and the company updated its guidance for both earnings-per-share and free cash flow for the rest of the year; no adjustments to our earnings-per-share forecast was needed to accommodate guidance.
AT&T’s earnings-per-share have grown steadily in the past decade as it continues to grow its international business and make prudent acquisitions, as well as expand margins via its expense rationalization program. Organic revenue growth is not a primary driver of EPS growth for AT&T and given the size and scope of its business, likely never will be. This is the rationale for the company’s purchase of DirecTV as well as the now-complete purchase of Time Warner.
Now that the Time Warner merger has been completed, we have upgraded our growth forecast to 6.4% annually. The legacy AT&T business should still produce low to mid-single digit earnings-per-share growth on its own via higher revenue and slightly better margins, while Time Warner’s higher rates of growth will help drive an additional 2% or so annually for the consolidated company.
Time Warner’s superior growth outlook is a major reason why AT&T bought it and we think it will begin to see that purchase bear significant fruit starting in late 2018 and into 2019.
AT&T’s price-to-earnings ratio has been volatile in the past ten years and of late, its earnings growth has not been appreciated by investors. AT&T’s current PE of 8.8 is the lowest it has been at any point in the past decade on a full-year basis, creating a potentially deep value situation for investors. This plays into AT&T’s conservative, safety-oriented shareholder base as not only does it pay a sizable dividend, but the stock is cheap.
With continued earnings growth and a reversion to the mean for its price-to-earnings multiple, AT&T represents strong value here for conservative, value-oriented investors. We are forecasting 8.8% in annual returns based solely upon reversion to the mean for the valuation, something we think is more likely now that Time Warner has come on board.
The dividend yield is also at the top end of its historical range at 6.6% and we expect it to fall over time as the stock moves towards our fair value through multiple expansion, outpacing future dividend increases.
AT&T’s quality metrics have declined somewhat in recent years as it has continued to take on debt to fund acquisitions. Indeed, it has one of the highest levels of debt of any company in the US market.
Recent increases were driven by funding for the Time Warner purchase, and we think improved earnings prospects will allow AT&T to reduce its debt over time. In addition, we think improving earnings will afford it growing interest coverage.
We expect the payout ratio to fall over time as the dividend rises more slowly than earnings, improving the safety of the dividend and the company’s ability to pay down debt. AT&T’s recession resistance will help as well should we see a downturn as its earnings actually grew slightly during the Great Recession.
AT&T’s principal risks at this point are pricing in its wireless segment and constant investments in infrastructure that are needed to stay competitive. However, diversification into DirecTV and Time Warner will help AT&T mitigate those risks somewhat. This diversification and its sheer scale are major competitive advantages for AT&T.
Overall, AT&T looks like it represents strong value here as it trades for roughly two-thirds of its fair value. It also offers the safety and income of a 6.6% yield and the prospects of further dividend increases. We are forecasting 21.8% total annual returns over the next five years, comprised of the yield as well as 6.4% earnings growth and 8.8% from multiple expansion.
AT&T’s reputation for being a safe stock is well intact as it offers the chance to buy a recession-resistant company at a great yield and trough valuation with stronger growth prospects thanks to Time Warner.
