Why I Bought AT&T Shares for $27.35 in December 2018

AT&T (NYSE: T) is the number one beaten down Dividend Aristocrat. Its dividend is above 7% and I scooped up shares on December 27th for $27.35 per share. I think the risk to reward is too enticing to pass up. The position is new and AT&T makes up 10% of my total portfolio.

The major risk is the $180 billion in debt. Although, my research shows that AT&T will have plenty of cash flow to whittle down its debt. And in the process, AT&T should be able to continue paying its dividend.

It’s not a risk-free move but the value opportunity is huge for long-term investors. Let’s dive in…

Major Risk for Long-Term AT&T Investors

There are a few elephants in AT&T’s board room, although, I’m most interested in the mammoth in the middle. AT&T’s debt load tops $180 billion after the Time Warner acquisition. That’s close to the size of Greece’s and New Zealand’s GDP.

The chart below shows the annual debt growth…

The last few years have been some of the best times to issue debt. Interest rates bottomed out in 2016 and AT&T has taken full advantage of the low-rate environment. But going forward, AT&T’s management has made it a priority to deleverage while continuing to pay its dividend.

As interest rates climb, it’s important that AT&T can meet its debt obligations without refinancing. Most of AT&T’s debt is fixed rate and the credit rating is investment grade (BBB) with a stable outlook from the S&P.

The chart below shows AT&T’s debt distribution…

The maturity dates are spaced out and AT&T should have the cash flow to service its debt. Also, keep in mind that AT&T can sell off some non-core assets to boost the rate of repayment. Before looking at cash flow numbers, let’s look at topline growth.

AT&T Revenue Growth Through Acquisitions

The majority of AT&T’s revenue growth from the last decade has come from acquisitions. In 2015, AT&T acquired DirectTV for $67.1 billion. This pushed revenue higher but it was a bit of a lemon at that price.

DirectTV is hemorrhaging subscribers. In the 3rd quarter of 2018, DirectTV’s traditional video segment lost 346,000 subscribers. Although, AT&T’s Mobility segment has added 550,000 new phone subscriptions in the U.S and service revenues are up 2.3% on a comparable basis.

Thanks to the recent Time Warner acquisition, revenue should hit a new high in 2018 and continue upward. Synergy is a buzzword that often leads to overpayment in acquisitions. But the Time Warner acquisition might have been a great move. Adding Time Warner content to AT&T will make it a powerful contender in the entertainment space.

Building an Impressive Lineup of Content

The AT&T and Time Warner merger was scrutinized with antitrust laws for good reason. Although, the risk of the deal being blocked has evaporated. A U.S. judge ruled that the deal doesn’t violate antitrust laws.

AT&T now owns an impressive lineup of content providers such as Cartoon Network, CNN, DC Entertainment, HBO, New Line Cinema, TBS, TNT and Warner Bros. Some of the individual shows, series, and movies from the providers include: Aquaman, Batman, Game of Thrones, Harry Potter, Inception, Lord of the Rings, Matrix Trilogy, Silicon Valley, Friends, Superman, The Flash, The Hangover, Veep, Westworld, and many other big names.

Content is king and AT&T’s future streaming services will give Amazon, Netflix, and other providers a run for their money. Netflix is going to have some tough years ahead since content will likely be pulled down as AT&T and Disney build out their own streaming services in 2019.

AT&T’s new streaming will complement AT&T’s growing Mobility segment. AT&T is vertically integrated and can offer very competitive pricing. The company continues to improve its network and reach with 5G and other technologies.

Free Cash Flow Covers Debt Repayment and Dividends

AT&T’s free cash flow has jumped around but it’s climbing steadily over the last few years. And the last four reported quarters come in just below $20 billion.

AT&T’s management expects 2019 free cash flow to be in the range of $26 billion and the payout ratio to be in the high 50s percent. After a recent dividend hike, AT&T will pay $2.04 per share in 2019 and has 7.278 billion shares outstanding. So $14.8 billion will go out in dividend payments and $11.2 billion will remain for paying the maturing debt and interest.

If cash flow comes in as expected, paying the dividend and debt shouldn’t be a problem. AT&T also has $8.6 billion in cash and marketable securities. Plus, the company can sell off non-core assets to meet any shortfalls or speed up repayment. AT&T also has access to $7.5 billion in credit revolvers available.

AT&T Shares Tank and the Dividend Yield Climbs

With the looming $180 billion in debt, investors have beaten down AT&T’s stock. It’s down 35% from its 10-year high in 2016 and in 2018 alone, AT&T shares plummeted 26%. Investors are fearful but it’s looking like a great value opportunity.

At my entry point of $27.35, AT&T’s price-to-earnings and EV/EBITDA ratios came in at 9.3 and 8.1, respectively. Although, one of my favorite value metrics is the dividend yield which came in at 7.46%. That’s up from a low of just below 5% in 2016.

Rule of 72: If AT&T keeps paying its $2.04 dividend, I’ll make the full investment back in dividends alone in less than 10 years. Although, there’s a high probability that AT&T continues raising its dividend.

Final Thoughts on Buying AT&T Stock

AT&T is a great risk to reward opportunity. The cash flow is solid and should cover both the debt and dividend payments going forward.

The one major downside I haven’t discussed is the risk of a recession. A lot of economic indicators are pointing to a downturn in the next two years. Still, with that in mind, I’m long AT&T shares.

Invest your time and wealth mindfully,

Brian Kehm

P.S. Interested in seeing my other recent stock purchase? The company isn’t a dividend payer but I think it will be as it accumulates huge amounts of cash. The price has dropped since I bought shares but I’ll double down as a recession hits.

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