AT&T: Dividend Increases Could Return, Bringing Valuation Multiple Expansion
Contributor since 2021 / 3077 Followers
Summary:
- AT&T’s earnings report shows strong performance, with customer growth leading top and bottom-line expansion.
- AT&T’s strong performance is expected to continue by providing value and cutting costs.
- The balance sheet is healthy and cash flow is quickly improving, opening the possibility of a potential dividend increase in the near future.
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Introduction
In my previous AT&T (NYSE:T) article, I had a buy rating on the company. At the time, I had two main reasons for this opinion. One, the macroeconomic conditions were expected to form a tailwind for AT&T in 2024 as the federal funds rate declined. Two, AT&T’s core telecommunications operation has been stable in bringing cash flow and moderate growth. Thus, for these reasons, I was bullish. Today, I continue to stand by my previous arguments. The Federal Reserve is still expected to start cutting the federal funds rate in 2024 while AT&T’s core operation continues to be strong. Beyond these reasonings, I also believe that AT&T is nearing a return of consistent dividend increases in the near future as a result of improving financials and balance sheet, which could create a tremendous catalyst for the company’s valuation appreciation potential. Therefore, I continue to believe that AT&T is a buy.
AT&T’s Strong Performance
AT&T has been tracking and performing in the right direction for multiple quarters following the divestiture of Warner Media, which formed Warner Bros. Discovery (WBD). The company has been consistently returning growth, margins, and stability.
First, the company’s customer acquisition has been strong, creating a foundation for increasing revenue and margins. AT&T’s postpaid phone subscribers grew 1.6 million customers year-over-year from 70 million to 71.6 million, which is about 2.3% growth. For fiber subscribers, total members grew by 1.1 million to 8.6 million from 7.5 million, which is about 14.67% year-over-year-growth. As such, the revenues of mobility services accounting for postpaid phone subscribers grew by 3.3% while the AT&T Fiber revenue grew by 19.5% year-over-year. Beyond the top line, ARPU or average revenue per user saw strong growth as well. For mobility services, the ARPU grew about $0.52 or about 0.94% and $2.69 or about 4.08% for fiber services, which resulted in 7% mobility services EBITDA growth and a 14.6% Fiber services EBITDA growth.
I believe these operating results are extremely healthy. Not only did AT&T increase the number of its customers, but the company achieved this feat while growing the ARPU, which implies that there is a strong value AT&T offers to its customers. With few promotions, assumed because ARPU increased, more members joined AT&T. Thus, I believe it is reasonable to assume that the company’s growth trajectory and momentum will be sustainable for the foreseeable future through ARPU increases and customer acquisitions.
Through AT&T’s strong performance in its core businesses, the company in 2024Q1 saw its cash from operations increase about 11.94% to $7.5 billion from $6.7 billion while the free cash flow increased to $3.1 billion from $1 billion year-over-year. Certainly, AT&T’s cash flow has strengthened.
Potential Dividend Increase
AT&T’s performance in the past few quarters was certainly strong, but one may argue that the company’s future prospects must also reflect continued growth for AT&T to afford dividend increases. I would like to argue that this is the case. The company’s growth and free cash flow prospects are strong, while the balance sheet and the dividend payout rate are at a manageable level.
As mentioned earlier in the article, I believe the growth in customers and ARPU is a testament to a strong value proposition, which could reasonably lead to an argument for sustained growth for the foreseeable future as a result of this value. Further, AT&T reported a low churn rate of 0.72%, which is lower than a churn rate of 0.79% in 2022Q1 and 0.81% in 2023Q1 showing a trend of declining churn rate. Thus, the declining number of customers leaving AT&T further supports the idea that AT&T provides a compelling value, which could continue to propel future growth.
Naturally, with greater scale and ARPU, the company’s margin tends to increase, but looking beyond what may be obvious, AT&T has another strong tailwind supporting the company’s continued growth in future free cash flow. AT&T’s peak investment intensity period for the 5G rollout has passed, allowing the company to gradually decrease the capital investments or Capex in the coming year, which increases the free cash flow.
During the 2024Q1 earnings call, the management team said the “capital investment levels have come down year-over-year” as AT&T “move past the peak of [the] 5G rollout.” This was apparent in the impact of the 2024Q1’s free cash flow, as the company spent $1.8 billion less in 2024Q1 than in 2023Q1. Further, for the entirety of 2024, the company is expecting the capital investment levels to be around $21 to $22 billion compared to $24 billion in 2023. Therefore, with the peak investment period being in the past, AT&T’s free cash flow will see a secular tailwind.
Beyond strong operations and its future expectations, AT&T’s debt load is improving. By the end of 2024Q1, AT&T had total assets of about $399.4 billion with a total liability of $278.8 billion bringing the total liability to asset ratio to about 69.8%, which is a significant improvement from the total liability to asset ratio of about 72.97% in 2023Q1. The improvement was the result of a reduction of “net debt by about $6 billion” according to the management team.
I believe a strong financial, future expectation, and improving balance sheet is a perfect recipe for a dividend increase, especially as AT&T’s current dividend payout, without accounting for future growth, is already on par with the company’s key industry competitor, Verizon (VZ). In 2024Q1, AT&T had a dividend payout ratio of 59.04% while Verizon had a dividend payout ratio of 60.46%. There was essentially no significant differentiating ratio between the two companies, yet Verizon continues its yearly dividend increases while AT&T has paused dividend increases since the divestiture of Warner Media. Therefore, given that AT&T’s dividend payout is within the industry standard with an expectation for the company’s operations and balance sheet to continue improving, I believe AT&T could start increasing its dividends in the coming few quarters.
Valuation
Given that AT&T starts its annual dividend increases, AT&T stock price could see a strong valuation appreciation. AT&T’s valuation multiple underperforms that of Verizon, and I believe the distinguishing factor behind the valuation discrepancy is the lack of dividend increase potential in AT&T’s stock. As such, given that AT&T is expected to start to increase its dividends in the near future, the company’s valuation multiple could be appreciated to match Verizon’s. AT&T has a forward price-to-earnings multiple of 7.91 compared to Verizon’s 8.69, which is about 9.86% higher than AT&T’s valuation multiple. This argument is likely reasonable, as both AT&T and Verizon’s EPS growth expectations for 2025 and 2026 are similar. AT&T after a -8.19% growth in 2024, the company is expecting 2.96% and 3.15% growth in 2025 and 2026 compared to Verizon’s 2024, 2025, and 2026 expected growth rate of -2.75%, 2.29%, 3.02%. Therefore, given a potential start to an increase in dividends, I believe AT&T has a valuation multiple appreciation potential of about 10%.
Risks
AT&T went through numerous risks in the past few years. Most notably, the company’s divestiture of Warner Media in an attempt to streamline the company’s core business in addition to managing the debt load has been the most aggressive action. And, as a result, the company’s growth and leverage ratios are becoming favorable; however, as a result of the previous history of risk from high debt load prior to the divestiture, the company’s management team may err on the side of caution. With limited investor expectations for dividend increases today, AT&T’s management team may see the current state as an opportunity to further strengthen the company’s balance sheet and future growth prospects before increasing shareholder benefits. Therefore, because the argument calling for a potential dividend increase is highly dependent on the management team’s decision in the coming few quarters, my bullish thesis may never materialize.
Summary
AT&T’s operation has been strong. The company is growing both its top and bottom line, fueled by strong and consistent growth in the customer base. Further, growing customers, ARPU, and declining churn rates signal that AT&T is providing value to its customers, which can be a future driver of customer acquisition. Further, the company’s free cash flow prospects are bright with declining capital investment plans, with balance sheet health quickly improving as a result of these positive results. Therefore, I believe AT&T is nearing a time when the company starts to increase its dividends again, opening a possibility of a valuation appreciation. For this reason, AT&T is a buy.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of T either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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