A December dividend hike of a penny has become the norm expected by AT&T (T) stock owners. AT&T’s latest penny hike marks the third time in as many years, giving investors 48 cents quarterly for owning T stock for an annual yield of 5.6%.
So, all looks good with AT&T stock, right? Well …
It is not easy to poke holes in a dividend stock that pays an annual yield of 5.6%, and a company that consistently ups its payout year-after-year. This is especially true when AT&T’s hike mimics what the company has done so many years before.
That said, I was discouraged with the one penny hike. The company was capable of doing so much more.
During AT&T’s last fiscal year, it spent $9.5 billion on dividends and created just under $10 billion in free cash flow. (Keep in mind, tracking FCF for telecoms is important because it removes capital expenditures from operating income in an industry that typically has very high capex.)
Thus, T paid out the overwhelming majority of its FCF on dividends last year, and has historically paid a large sum of its cash on dividends.
Times have changed for T following its acquisition of DirecTV and the purchase of two wireless carriers in Mexico, however. During its last quarter (the first quarter after purchasing DirecTV), free cash flow jumped to $5.5 billion vs. $3.5 billion in the same period last year.
Furthermore, management went on to guide for free cash flow of at least $15 billion this year and expects double-digit growth in 2016. In other words, free cash flow will soar 50% this year as operating costs decline and profits soar, but the dividend is rising just 2%.
With that said, T will achieve revenue and profit growth over the next two years that it has not experienced in quite some time. As a result, there is potential for upside in AT&T stock.
Why T Should Give More to Investors
Historically, AT&T isn’t a top performer. Rather, it’s known for its low beta and high yield, and as a safety investment in turbulent times. So investors should not assume that the AT&T stock price will struggle to move higher over the next year, regardless of the company’s growth.
AT&T’s dividend is the one thing that its shareholders count on each and every year to positive returns, and the fact that the company did not use its newfound FCF to give investors a bigger dividend hike this year is disappointing to say the least.
While AT&T’s debt has soared 55% over the last year to nearly $127 billion, the giant telecom still has many years before the majority of that debt matures, and could responsibly manage its debt with a couple billion dollars in annual payments.
That leaves $2 to $3 billion from AT&T’s FCF, which could be used for stock buybacks; but with a $210 billion market capitalization, it would be hard for $2 billion in annual buybacks to create legitimate shareholder value.
Instead, AT&T’s appeal would have skyrocketed by using that $2.5 billion to surprise the market with a 20% hike to its dividend. In retrospect, a 20% dividend hike would still be mediocre next to the 50% increase in its FCF.
Nevertheless, T is a mature company with a mature stock: Neither AT&T’s stock or its company is going to double in value, not any time soon, and its yield remains the best way for AT&T to reward shareholders for their ownership in the company.
While AT&T’s 2% dividend hike will not discourage me to divest my stake in the company, it is a discouraging action nonetheless, and suggests that no matter how much AT&T’s FCF grows stemming from recent acquisitions and reduced costs, T management will give investors an extra penny a year.
That’s a bad sign for anyone looking to maximize their returns
As of this writing, Brian Nichols was long T stock.
