- AT&T is a communications leader in the United States and Latin America.
- AT&T provides the infrastructure to make the modern backbone of personal and commerce life work—the internet.
- The established nature of AT&T reduces risk.
Communications company, AT&T (NYSE:T) certainly exhibits qualities which conservative long-term investors desire. However, Wall Street dismally awarded company shareholders with a stock return of 26% versus 53% for the S&P 500 over the past five years (see chart below). Moreover, income-oriented retirement investors should find its dividend appealing. AT&T’s yearly payout translates into a notoriously high dividend yield of 5%. However, it's dangerous for investors to invest based on yield alone. Let’s examine the business that generates the income.
AT&T conjures up images of a stodgy old phone company providing what it calls “Legacy” voice services. Interestingly, this part of the business is declining. Modern day AT&T operates as a diverse provider of voice, video and data communications via landlines, wireless devices and satellite dishes.
The world is increasingly becoming internet centric. Over 3.2 billion people are on the internet, according to Statista.com. Smartphones will increasingly be the center of commercial and personal life. Moreover, as television consumption trends towards streaming, the internet’s relevance will only increase. Smartphones and streaming services can’t operate without companies like AT&T providing the bandwidth.
This makes AT&T a toll bridge company. AT&T provides the infrastructure for the internet, which allows modern commerce. It would prove costly for a new competitor to construct new communication infrastructure that could compete with AT&T. Long-term investors find toll bridge companies appealing because they provide the essentials of other businesses and consumers. Intermediaries, such as retailers and television stations, continually worry about obsolescence in the face of technological change. AT&T is an original provider.
DirecTV acquisition represents another way AT&T can be a toll bridge. Streaming companies in the future may want to use AT&T’s satellite infrastructure for their services. AT&T DirecTV apps serve as a viable competitor to streaming, assuming content creators continue to cooperate. Of course, it should remain in the content creator’s best interest to do so if they want content distributed across AT&T’s networks.
AT&T resides in a mature phase, which means it doesn’t provide a great deal of growth on a YoY basis. AT&T’s revenue and free cash flow grew at an annualized rate of 3.4% and 1.5%, respectively, over the past five years. This came from organic and non-organic means. Notably, the established nature of this company implies relatively small risk for investors. Young companies operating in new industries could be crushed by the competition that wants to dominate. Investors should expect the continuation of slow growth.
AT&T’s balance sheet could be better, but it doesn’t appear too risky for the conservative investor. AT&T ended FY 2015 with $5.1 billion in cash amounting to 4% of stockholder’s equity, which is a little low. Long-term debt equates to 96% of stockholder’s equity, which resides a little in the high range for my taste. However, operating income exceeds interest expense by six times, which is fine.
Stock behaving like a bond
All of these factors translate into a stock behaving like a bond (though still a stock with inherent risks) with the largest part of its total return coming from dividends. AT&T appeared to prefer dividends over stock buybacks in the past couple of years. Hopefully, this will continue. AT&T’s dividend resides on rock solid ground. Last year, the company paid out 64% of its free cash flow in dividends, which is low for a mature company. Currently, the company pays its shareholders $1.92 per share annually. This yearly income can be purchased for a mere $38.59 per share, translating into the aforementioned generous dividend yield of 5%.
To add icing to the proverbial cake, AT&T trades at a P/E ratio of 17 versus 23 for the S&P 500. This certainly represents a plus in a market where good companies with good valuations are hard to come by. AT&T’s low valuation adds upside potential to the capital gain side of the total return equation.
Long-term investors looking for market-beating returns may be a little disappointed with AT&T. However, its dividend provides an incentive for holding the company long-term until any potential capital gains materialize. It’s doubtful that the company will go anywhere anytime soon. AT&T stock definitely deserves a look.