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AT&T Investor Guide: High Yield, Low Valuation But Not Without Risks

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The following originally appeared on Suredividend.com

AT&T Inc. (NYSE: T) is the biggest telecommunications company in the US based on its $234 billion market cap.  The company can trace its roots back to the Bell Patent Association, a legal entity created to protect the patents of telephone inventor Alexander Graham bell.

The company’s long history should appeal to investors looking for stability.  But where AT&T really stands out is its status as a high dividend stock with a low valuation.

AT&T currently offers investors a dividend yield of 6.3 percent.  There’s an argument to be made that AT&T is one of the safest 6+ percent yielding stocks available on the market today given its dividend history, stable utility-like cash flows, and diversification.

The company is diversified both internationally and through its operating segments. AT&T operates under 4 segments: Communications, Media, International and Advertising & Analytics.

The communications segment is by far the company’s largest, responsible for $150 billion in revenue in fiscal 2017.  For comparison, the other three segments combined generated around $40 billion in revenue over the same period.  The communications segment provides video, mobile, broadband, and other communication services to individuals and businesses in the United States.

AT&T’s Media segment is a result of the recent acquisition of Time Warner.  The deal was completed on June 15th and will be transformative for AT&T, as it turns the company into a vertically integrated content powerhouse.  AT&T now both provides and delivers content.

Growth Outlook                                   

AT&T is not a fast-growing stock.  The company operates in the mature media and communications sectors.  From 2008 through 2017, AT&T has grown its earnings by 3.9 percent annually, and dividends at just 2.3 percent per year. 

For comparison, inflation averaged around 1.9 percent annually over the same time period.  AT&T barely generated real dividend growth over the last decade.

AT&T is not expected to grow rapidly over the next several years, either.  With that said, the recent Time Warner acquisition could be a boost.  Wall Street hopes to see AT&T grow its earnings and dividend 4-5 percent annually over the next 5 years, slightly ahead of average growth rate since 2008.

Valuation & Total Return Potential

Fortunately for prospective investors, AT&T appears undervalued at current prices. AT&T’s average price-to-earnings ratio from 2008 through 2017 is 13.4.  The stock is currently trading at a P/E ratio of just 9.5 using expected 2018 earnings-per-share of $3.45.

AT&T is still a high quality business with a long history of success and decent-if-unspectacular growth prospects.  A fair price-to-earnings ratio of 13.4, in line with its historical average, is reasonable for AT&T.

If AT&T’s price-to-earnings ratio were to revert to its historical average over the next 5 years, this would add an additional 7 percent a year to total returns.

The Bear Case For AT&T

While there are compelling reasons to own shares of AT&T, the company is not without its risks.

First, AT&T has a sizeable debt load.  The company currently has $163 billion in total debt, including $134 billion in long-term debt.  The company’s debt incurred an interest expense of $6.1 billion in fiscal 2017.  For comparison, AT&T generated $39 billion in cash flow from operations over the same time.

If AT&T’s cash flows were to significantly decline, high debt levels and interest expense would hasten the decline of the company.

And there is reason to be on alert about AT&T’s future.  The company’s legacy satellite television and wireline products are in decline due to cord cutting. Moreover, AT&T is betting big on Time Warner.  If the acquisition does not integrate as planned, AT&T will have wasted a significant amount of resources. 

There’s no question that AT&T exists in a capital intensive business that is highly competitive.

Final Thoughts On AT&T

AT&T is a conservative, high quality stock.  In fact, AT&T has increased its dividend every year for 34 consecutive years.  The stock currently offers investors a dividend yield of 6.3% - over 3 times greater than the S&P 500’s yield.

AT&T’s business model creates very stable cash flows.  The company combines recurring subscription billing with contracts.  This gives AT&T stock a low volatility and resilience during recessions.  AT&T scores high marks for safety qualitatively.  While AT&T does carry a high amount of debt, its safe cash flows leave little doubt the company will be a going concern far into the future.

Investors who buy AT&T today get more than a high yield and safety.  They also get high expected total returns.  While AT&T’s growth outlook is positive, this stock is unlikely to generate serious earnings-per-share growth.

But it is undervalued.  Valuation multiple mean reversion is a key factor in my AT&T investment thesis over the next 5 years.  With that said, investors can still expect total returns of 10-11 percent a year without any increase in the valuation multiple.

Buying AT&T stock today allows investors to invest in an undervalued security – and get paid to wait for a valuation boost with a healthy 6% dividend yield.  On top of that, the dividend is very likely to increase every year, just as it has in each of the last 34 years.

With that said, AT&T is not without risks.  Investors should weigh the pros and cons of AT&T stock before making an investment.

Disclosure: The author is long AT&T.

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The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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