T - Bargain Alert: 2 'Coiled Spring' Dividends Waiting To Rip Higher

2023-06-16 07:35:00 ET

Summary

• I am transforming my portfolio into a perpetual cash-flow machine.
• Discounted dividends are much-needed fuel for this machine.
• Unleash your portfolio’s true potential with the income method.

Co-authored with "Hidden Opportunities"

Science has always been one of my favorite subjects since middle school. Among the ocean of topics, I particularly enjoyed learning about metals and carbon compounds in chemistry, and velocity, energy, and electricity in Physics. My interest in these topics formed the premise of pursuing engineering in college and graduate school.

One of the most fundamental components of most mechanical devices is a simple elastic object called the spring. Springs come in a wide variety of shapes and sizes. But no matter how they look, they all work the same way; they store and release energy. Whether it is automobiles and compressors, the pen you write with, or the mattress you sleep on, the tiny spring forms the basis of our everyday lives.

Similarly, discounted securities form the basis of long-term investing, and dividend-paying ones have tremendous potential “energy” to unleash upon your portfolio. We will now discuss two 'coiled spring' dividends that have the potential to be very rewarding for your long-term income portfolio.

Pick #1: AT&T - Yield 7%

U.S. telecom stocks had quite the roller coaster recently when the rumor mill began discussions around Amazon’s ( AMZN ) intent to offer prime members low-cost or free wireless services . AT&T ( T ) is down significantly due to the news and potential disruption concerns in the oligopoly market, but the entire charade lacks tangible substance.

Firstly, Amazon has denied the initiative.

"We are always exploring adding even more benefits for Prime members, but don’t have plans to add wireless at this time."- Amazon spokesperson

Secondly, U.S. telecom has seen this before, and it was through another Big Tech player just a few years ago. Google ( GOOG ) (GOOGL) launched Fi Wireless (Formerly Project Fi) in 2015, with the threat of affordable wireless. This announcement and subsequent launch brought fear among the investor community, with the expectation of disruption in the industry. Mr. Market reacted predictably, creating ripples in the stock prices of AT&T and Verizon ( VZ ). Source

Since its inception, Fi has operated as a Mobile Virtual Network Operator (‘MVNO’). This means it doesn’t own or manage its infrastructure but utilizes those of the more established players – T-Mobile ( TMUS ) and US Cellular ( USM ). Google doesn’t report subscriber count, but a guesstimate from Prepaidcompare.net pegs the number in the 500,000 range.

Small adoption aside, the noteworthy point is that GOOG didn’t bother setting up its own infrastructure. And AMZN, if they decide to pursue this in the future, wouldn't go down that path either. Setting up reliable wireless infrastructure across the fourth largest country in the world is a costly ordeal, and the e-commerce giant will likely partner with existing telecom companies to provide a focused service to its members.

Mr. Market, as always, reacted without thinking, and the stock fell after the rumors floated.

A lot has been discussed about AT&T’s upcoming debt maturities. AT&T continues to project $16 billion (or higher) free cash flow for FY 2023. Based on the $8 billion expected dividend payments for the fiscal year, the company will have another $8 billion to extinguish its maturing debt. Considering ~$6 billion is due before December 2023, the company is well-positioned to accomplish this without causing an impact on shareholder income.

Think this is impossible? In Q3 2021, AT&T's total debt was recorded at $171 billion, which has been reduced to $143 billion in ~ two years. Sure, the Warner Bros. Discovery ( WBD ) spin-off boosted the initial debt reduction efforts. However, with the 5G and Fiber capex requirements tapering off from FY 2024, the company’s predictable earnings are well-positioned to generate higher FCF and reduce debt meaningfully. Over the next five years, we can expect to see total debt decline to $109 billion, and this aligns well with the company’s objectives to achieve a net debt-to-adjusted EBITDA ratio in the 2.5x range.

In this higher interest rate environment, debt is a critical factor weighing down AT&T’s valuation. But business performance remains strong with growing 5G and Fiber coverage. FY 2023 numbers will show Adj. EBITDA growth and adequate dividend coverage. While investors may not see dividend increases this year, the current payment is sustainable. At a 6.1x forward PE, AT&T is massively discounted and presents a solid bargain from a business that forms the basis of digital connectivity in America. Grab more shares to collect the 7% yield and take advantage of the irrational and impatient sell-off.

Pick #2: BTO - Yield 9.7%

John Hancock Financial Opportunities Fund ( BTO ) is a Closed-End Fund (‘CEF’) composed heavily of U.S. banking, capital markets, insurance, and financial services firms. Considering to invest in a fund consisting primarily of U.S. banks right after three bank failures can be unnerving. But the best opportunities are born in the deepest of sector-level crises, and BTO ’s active management strategy has proven to be effective in risk management and sustainable shareholder returns. Source

Looking at BTO’s top portfolio names as of March 2023, notable changes have occurred since December 2022. BTO currently has KKR & Company ( KKR ) and Ares Management ( ARES ) as its top holdings. This is a prudent shift into alternative assets as they provide the unique combination of higher yields and a defensive return stream with a low correlation to broad asset classes.

BTO has 163 holdings but minimal exposure to banks that may be categorized as ones with a risky specialty. The CEF is modestly leveraged at ~21% to boost the 5.2% average portfolio coupon. BTO’s quarterly $0.65/share distribution calculates to a spectacular 9.7% annualized yield.

Notably, BTO has experienced a sharp price (and NAV) drop since March 2023 due to the U.S. banking sector's woes. From Q1 earnings, we see that banks are getting highly selective with their lending and have significantly increased their loan loss provisions. Despite these precautionary measures, the sector is resilient, and we will see more prominent firms strengthen from the crisis. Over time, BTO is well-positioned to see continued NAV recovery.

Prudent long-term income investors should recognize that the point of heightened fear is the time when generational opportunities are born. This is the time to buy a diversified pool of U.S. banking stocks through a quality fund like BTO. You can sit back, collect the income, and look at your holding when the hysteric crowd wakes up and realizes what they missed.

Conclusion

AT&T and BTO are attractive dividend payers in the current market and offer up to +9% yields. However, these are only two of our strong and diversified income lineup.

At High Dividend Opportunities, we implement the income method in our investments. Our objective is to convert a portfolio into a reliable and sustainable income producing machine. This machine runs all day everyday, day and night. It runs when you are awake, and it runs when you are asleep. The HDO machine is built with +42 individual dividend payers and targets an overall yield of +9%. Our machine is built to last a lifetime and has been predictably chugging along through this bear market.

The parts for the cash machine are on sale, and you can unleash the true potential of your portfolio by buying these bargains. Sit back, relax, and let these coiled springs do what they do best.

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