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AT&T: Compelling Even Without Growth

AT&T (T) traces its roots back to 1876 with Alexander Graham Bell’s invention of the telephone. Since that time “Ma Bell” was forced to split into “baby bells,” rearranged via divestitures and mergers and today ultimately stands as the “new” AT&T since 2005 when SBC Communications acquired AT&T Corp.  Despite moving through 130+ years of history, the company still maintains the same basic business model: connecting people.

To get a quick and clear view of this company, we’ll look through the powerful lens of F.A.S.T. Graphs™. Below we have included the Earnings and Price Correlated graph to demonstrate that where earnings go, price eventually follows. Note that this graph only dates back to 2006 – reflecting the “new” AT&T.
Over this time period earnings have grown by about 4.5% per year with 2 negative years mixed in among 6 positive ones. Additionally, the dividend payout has been high and steady – growing by roughly 4% per annum as well. However, it should be noted that AT&T’s policy has been to increase the quarterly payout by just a penny in the last 6 years; dropping the short-term growth rate to just 2%. Today shares trade at just less than 14 times blended earnings with a dividend yield of 5.3% and thus a corresponding payout ratio of about 70%.

Perhaps most notable about this graph are the growth rates. Upon observing both the size and history of this company, a potential investor might conclude that it’s been steadily profitable but destined to be a slow grower. That is, the prospective investor might believe that they are “late to the party.” And while it might be true that the days of double-digit growth are far behind, this idea alone does not necessarily preclude AT&T from being a successful investment. In fact, AT&T’s own history works to prove this point quite exactly.
At the end of 2005, AT&T was trading at about 14.2 times earnings. Today, as depicted above, shares change hands at a multiple of about 13.7. In other words, the investor of 8 ½ years ago didn’t see any P/E multiple expansion. Couple this with just 4.5% earnings growth and it would seem that AT&T would have been a lackluster investment. Yet these facts miss out on the power of a healthy dividend.

Below we have included the performance table spanning back to December 30th of 2005. During this time, the S&P 500 index had capital gains of 5.4% per year and a total return of 6.7%, including dividends. If you were to look solely at the capital appreciation of AT&T, you would see that while earnings grew by 4.5% annually, the share price of AT&T grew by 4.3% - less than the index and a direct result of the slight P/E compression. At first blush, by focusing on price alone, one might conclude that shares of AT&T did indeed progress sluggishly.

Yet take a look at the dividend cash flow. A hypothetical $10,000 investment in AT&T would have netted an investor $5,500 in dividends as compared to just $1,700 provided by the index. This single concept allows the total return of the company to jump to 8.4% per annum and provide a decidedly higher annualized investment return.

Moreover, this concept is magnified if an investor were to reinvest the dividend proceeds. Below we can see that instead of 8.4% annualized returns, the high dividend yield would have allowed an investor’s capital to compound at nearly 10%. There’s something to be said for a strong dividend yield paired with reasonable valuations and time.

Of course this information is only useful if the payouts remain sustainable. To this point AT&T has not only paid, but also increased its dividend for 30 consecutive years.

Perhaps more pertinently, the company has shown a healthy cash flow with a propensity to cover its main obligations. For instance, below we have included the Fundamental Underlying Number (FUN) Graph showing the cash flow per share (cflps), dividends paid per share (dvpps) and capital expenditures per share (capxps). Here we can see that the company has maintained a healthy source of cash – covering both its payouts and capital expenditures in each year.

Obviously this could change in the future, but if things stay on pace, AT&T has the ability to continue to invest and pay its dividend. Note that the rates of payout increases haven’t been spectacular – especially as of late – but the fact that it’s increasing is reasonable news. This is particularly observable given the high starting yield.

As a comparison, if you looked at a company like Coca-Cola (KO) or  Procter & Gamble (PG) - with yields closer to 3% and expected dividend growth of perhaps 7% moving forward – it would take 13 years to reach the same payout of AT&T (if AT&T grew payouts by 2% per year) and 22 years to nominally produce more expected income. And that’s without considering the effects of being able to reinvest larger dividend payments for the first decade of your investment horizon. In short, it can be all too easy to discount AT&T as a slow grower – yet getting paid to wait has both explicit and implicit rewards. That is, if the dividend payout remains sustainable, it can quite literally pay off both today and tomorrow.

As a compliment to the dividend, AT&T has also been reducing the common shares outstanding (csho). For instance, the company had about 6 billion shares outstanding at the end of 2007 versus about 5.3 billion last year – a 2% yearly reduction.

It is true that this program has been somewhat inconsistent, but over the longer term it can add meaningfully to per share growth. Additionally, AT&T approved a 300 million share repurchase authorization in March of this year representing about 6% of the company’s outstanding shares.

Finally, we can take this information that we have observed and apply it on a forward basis. Specifically, we have included the Estimated Earnings and Return Calculator below. Earnings per share are assumed to grow from last year’s $2.50 to $3.14 by the end of 2019 – surely not overwhelmingly impressive, but precisely in line with recent historical growth rates. Likewise, dividends per share are assumed to grow from $1.81 to $2.18 by 2019 – just a 3% rate. Yet despite this slow growth, if AT&T were to trade at 15 times earnings in the future, this would indicate a return of nearly 10% per year.

Now, it should be underscored that these numbers are simply derived from the median amongst the consensus of analysts’ estimates. Yet collectively they do provide a reasonable baseline for evaluating the company.

Overall we believe AT&T is a strong and storied company that presents an interesting investment thesis. Unlike many other exciting opportunities, this appeal isn’t derived from expected growth. In fact, quite the opposite is true. In a no growth scenario, an investor might collect the 5%+ dividend, could see a percent or two of EPS growth via share buybacks and reinvest the proceeds for the potential of high single digit returns – without the company as a whole truly growing at all.  If AT&T is able to actually grow a bit, the results could be even better. However, as always, we recommend that the reader conduct his or her own thorough due diligence.

Disclosure:  Long T, KO & PG at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.