Equity research: AT&T: No Dividend Raise, But Here's Why It Doesn't Matter

 

Cash Flow Story Remains Intact, Deleveraging Will Continue

Jan. 17, 2021

Here is the article.

Here are my notes:

1. Cash flow $26 billion 
2. Movie business couldn't operate normally.
3. 2021 same cash flow - growth investments for 5G, HBO Max, etc. are all paid for. 
4. Cash flow - total 45 billion during last four quarters - Per YCharts?
5. 20 billion a year for the growth of its 5G network, replacement of older lines and other assets
6. 25 billion for shareholder returns - via dividends and/ or buybacks, debt reduction, or acquisitions 
7. 
   

AT&T is not a growth company, and it likely will never turn into a growth company. But even slow-growing companies can be great investments. In this case, AT&T is generating huge cash flows that allow for ample shareholder returns, and its valuation is so low that not a lot of underlying business growth is needed for shareholders to see solid returns.

During 2020, the pandemic-stricken year, AT&T has generated free cash flows of ~$26 billion, despite the fact that some of its business units, such as the movie business, couldn't operate normally. AT&T's CFO has recently stated that the company plans to generate a similar amount of free cash flow this year -- even after growth investments for 5G, HBO Max, etc. are all paid for. This is possible thanks to AT&T's very strong operating cash flows, which totaled $45 billion during the last four quarters (per YCharts). AT&T invests about $20 billion a year for the growth of its 5G network, replacement of older lines and other assets, and so on, which leaves a little more than $25 billion left over that can be used for shareholder returns (via dividends and/or buybacks), debt reduction, or acquisitions.

In the past, AT&T's previous management teams oftentimes were focused on acquisitions a little too much, heavily overpaying for DirecTV, for example, relative to the value the business has now, a couple of years later. It seems that current management will not be doing the same mistake, however, as AT&T is more prone to selling non-core assets instead of making new acquisitions since the Time Warner takeover closed. A large part of AT&T's free cash flows can thus be used for debt reduction, as takeovers are not eating up cash any longer.

Here are my notes:

1. 26 billion cash flows, 15 billion - dividend costing - 11 billion of debt
2. Q4 2020 - net debt $130 billion to $135 billion by the end of 2021
3. DirectTV for $15 billion or more - debt reduction
4. If possible, debt will be less than $120 billion 
5. 45 billion debt reduction in next few years. 

Based on management's current outlook, investors can expect that debt reduction will continue during the current year. With a forecasted $26 billion in free cash flows, and dividends costing the company about $15 billion, AT&T could pay down $11 billion of debt this year from free cash flows alone. When we further include the paydown during Q4 of 2020, which isn't visible in financial reports yet, AT&T's net debt could come down to about $130 billion to $135 billion by the end of 2021. This does not include potential additional debt reduction through asset sales yet. AT&T is looking at selling DirecTV for $15 billion or more, while smaller assets are also being monetized. If a DirecTV sale is finalized this year, AT&T could possibly end 2021 with less than $120 billion in net debt, which would be a very large reduction relative to the baseline a couple of years ago. Even if there is no DirecTV sale, the outlook for around $130 billion of net debt by the end of the current year is quite positive, I believe. That equates to a ~$45 billion reduction in total net debt over a couple of years. On top of that, AT&T's leverage would be at a very reasonable level relative to the EBITDA the company generates:

In a scenario where AT&T's net debt is $130 billion at the end of this year, while AT&T generates EBITDA of $56 billion during 2021, in line with analyst estimates, AT&T's trailing net debt to EBITDA ratio will be 2.3 a year from now. That doesn't sound like an overly high amount of leverage, especially considering that interest rates are at record lows and that AT&T has already refinanced dozens of billions of debt at these low rates.

Even With No Raise, AT&T Offers An Attractive Income Stream

I expect that AT&T will announce a dividend raise in 2021 in order to keep its Dividend Aristocrat status, but even if that doesn't occur, the income stream that the company offers would remain very solid. AT&T yields 7.1% at the time of writing, which is about 4-5 times as much as the broad market's yield. If investors do never again get a dividend raise, and investors just continue to reinvest dividends at an average yield of 7%, an investor that buys now will have a yield on cost of 10% five years from now. For someone just looking for a major blue-chip stock that is relatively resilient to recessions and that offers a high yield that is well-covered, AT&T could thus be a very solid choice. I personally think that a couple of other names are even more attractive for income investors, such as Enterprise Products (EPD), but that is a more volatile stock. Enterprise Products also issues a K-1, which may be a problem for some investors. Those looking for a solid income yield without much hassle could be very happy with an investment in AT&T at current valuations.

Julia's notes:

1. upside 30% in a couple of years - solid upside, not a gigantic return potential 

Upside Potential

Shares are inexpensive, but that alone will not necessarily lead to gains. Oftentimes, a catalyst or sentiment change is needed to make a value stock's share price rise. I believe that something like that could occur with AT&T's stock over the coming one or two years. Once deleveraging has progressed and debt levels are somewhere between $120 billion and $130 billion, more investors may realize that debt is not really a problem for AT&T. Since AT&T's dividend yield will still be high while interest rates remain at a quite low level, more income investors may start to pile into the stock, which could give it the tailwinds it needs to get back to previous highs. Just one year ago AT&T traded in the high $30s, thus an upside potential of up to 30% is not at all unlikely over a couple of years. AT&T is thus not an investment with a gigantic return potential, but with solid upside over the next one to two years, while also offering a sizeable income yield.