The stock market continues to exhibit a great deal of volatility, which means income investors might want to refocus their portfolios on high-quality dividend stocks. For these investors who may be getting nervous about the market’s future direction, strong dividend payers are valuable for their consistent income.
In the pursuit of high-quality dividend stocks, we recommend investors consider the Dividend Aristocrats, a group of 66 stocks in the S&P 500 Index with at least 25 consecutive years of dividend growth.
AT&T (NYSE:T) is a high-quality Dividend Aristocrat. AT&T stock has lagged the overall market this year, declining 17% while the S&P 500 Index is flat year-to-date. But AT&T has promising growth potential thanks to its Time Warner acquisition. It also has an attractive valuation, and a high dividend yield of 6.5%.For these reasons, AT&T is our top-ranked Dividend Aristocrat right now.
Business Overview & Recent Events
AT&T is a giant telecommunications company. It operates wireless, broadband, and video services in the U.S., along with the DirecTV satellite television brand. It also operates Time Warner as a result of the massive $85 billion acquisition in 2018. Time Warner brought along a number of businesses of its own, including a variety of media properties such as HBO, CNN, and many others, plus a major movie studio. AT&T also has a sizeable presence in Latin America. In all, the company generated over $181 billion in revenue last year.
The current environment is challenging for AT&T due to the coronavirus crisis that has brought down the entire global economy. The prospect of a deep recession is difficult for any large multinational company, but AT&T has shown resilience due to its recession-resistant business model. Demand for wireless, broadband and more of AT&T’s services continue to see high demand, even with the U.S. economy officially in recession.
AT&T reported steady first-quarter results. For the quarter, the company generated $42.8 billion in revenue, down 4.5% from the same quarter last year. Not surprisingly, the coronavirus crisis was the culprit, as it dealt a significant disruption to the global economy. Growth in domestic wireless services and business services only partially offset declines in domestic video, legacy wireline services, and WarnerMedia.
On an adjusted basis, earnings-per-share of $0.84 declined 2.3% year-over-year. AT&T attributed a $0.05 per share decline to the coronavirus, meaning without the coronavirus, earnings-per-share would have increased approximately 3.5%.
Importantly, the company remained highly profitable and cash-flow positive. AT&T generated free cash flow of $3.9 billion during the first quarter. Maintaining positive free cash flow allows AT&T to continue paying down debt and paying dividends to shareholders. AT&T’s net-debt-to-EBITDA ratio stood at a reasonable 2.6x at the end of the quarter.
While the coronavirus has taken a toll on AT&T, it has so far been a fairly modest impact thanks to the resilience of AT&T’s business model. And, once the coronavirus crisis is over, AT&T has significant growth potential in the years ahead.
Dialing Up Growth
AT&T has a number of growth catalysts going forward. One example is 5G rollout. AT&T’s 5G expansion continues, and on April 22nd the company announced its 5G network had reached 190 markets across the country. AT&T’s 5G network now covers more than 120 million people. Faster speeds will allow AT&T to remain near the top of the U.S. wireless industry.
Separately, AT&T’s acquisition of Time Warner is a major growth catalyst. The acquisition was an important step forward in AT&T’s evolution to become not just a distributor of content, but a creator of content as well. This is a strategic imperative for many content distributors—for example, close rival Comcast Corporation (NASDAQ:CMCSA) acquired NBCUniversal for a foothold in content. The reason is simple—owning content provides distributors with a valuable hedge against rising costs of content.
In the age of streaming, the purchase of Time Warner provides assurance that AT&T will be able to remain in demand, no matter which direction consumer trends happen to go. AT&T launched its HBO Max streaming platform on May 27th, and reported 90,000 mobile downloads on the first day. HBO Max offers subscribers approximately 10,000 hours of programming. It also means even if AT&T’s cable and satellite businesses fall out of favor with consumers due to cord-cutting, AT&T will be able to keep pace in streaming.
We believe 4% annual earnings-per-share growth is a reasonable estimation for AT&T over the next five years. Earnings-per-share growth will be fueled by a combination of revenue growth, and the acceleration of share repurchases once the coronavirus crisis ends. Continued growth will allow AT&T to pay shareholders a hefty dividend, and also raise the dividend payout each year.
AT&T: Dividend Aristocrat With A Secure Payout
AT&T has increased its dividend each year for the past 36 consecutive years. As a result, it is a member of the exclusive Dividend Aristocrats list. We believe the Dividend Aristocrats are among the best stocks to buy and hold for the long-term. The Dividend Aristocrats are a group of companies that share multiple qualities, in particular the ability to remain profitable during recessions. This is why they have maintained such long histories of increasing their dividends every year.
AT&T continued to raise its dividend during the Great Recession of 2008-2009, as well as other economic downturns over the course of its 36-year streak. This gives shareholders a reasonable level of confidence that the company can continue to raise its dividend in the years ahead. The company’s dividend is secured by strong cash flow. Last year, AT&T generated over $29 billion in free cash flow. Dividends accounted for approximately $14.9 billion of cash outflow last year, meaning the company easily covered its dividends in 2019.
While the coronavirus crisis has taken a steep toll on the global economy, AT&T continued to generate positive free cash flow in the first quarter. Free cash flow of $3.9 billion sufficiently covered dividend payments of $3.7 billion. The payout ratio tightened in the first quarter, but AT&T’s recession-resistant business model is a promising sign, even if conditions remain difficult throughout 2020. After all, consumers will always want their wireless, broadband, and favorite shows and movies—even in a recession.
With a high dividend yield of 6.6%, we view AT&T favorably as an income stock. Shares of AT&T appear undervalued as well. The stock has a price-to-earnings ratio of approximately 10, which we believe is too low for a company of AT&T’s caliber. If the P/E multiple expands to a higher level of 12, which is in-line with the 10-year average valuation of AT&T stock, it would result in a significantly higher share price for investors. For example, an expanding P/E multiple from 10 to 12 over a five-year period, could increase shareholder returns by 3.7% per year.
Therefore, the combination of 4% expected earnings-per-share growth, the 6.6% dividend yield, and a 3.7% annual boost from a rising P/E multiple, could produce total annual returns above 14% per year over the next five years.
Final Thoughts
The S&P 500 has rallied hard off of its 2020 lows, but the stock market continues to exhibit volatility. With the U.S. economy officially in recession, investors may want to consider getting more defensive in their stock portfolios. High-quality dividend stocks can outperform in a market downturn due to their high yields and steady payouts.
AT&T is a Dividend Aristocrat with a long history of surviving recessions, while continuing to raise its payout each year. The stock has a high yield above 6%, and an attractive valuation. As a result, AT&T is our top-ranked Dividend Aristocrat right now.