ROKU - Buy AT&T For A Strong Dividend And Hidden Growth

2023-04-25 18:01:42 ET

Summary

• AT&T currently has a lot of backwards looking hate that dismisses the positive changes of the past 2 years.
• AT&T has a large well covered dividend, is rapidly paying down debt that is financed out at only 4.1% and will likely buy back shares in a few years.
• Heeding Charlie Munger, I look for companies with parts that the stock market does not properly assign value - AT&T has 2 hidden growth catalysts.
• Retirees can buy AT&T for the mailbox money, while younger investors use the dividends to buy other stocks.
• Buy AT&T shares in the teens.

I have been following AT&T ( T ) since the early 1980s when my mom started working there in the Ma Bell days. I have watched every transition from being broken apart into Baby Bells, to the recombination of many to largely recreate the Bell system, to the DirecTV and Warner Brothers failures to execute.

Now, I am watching AT&T focus on their core competencies and using technology to advance their business. Unlike the sour taste many have from the Warner Brothers sale to Discovery ( WBD ) and the resulting dividend cut, I am seeing the company turn back into a sweet deal with a large and well covered dividend.

AT&T is dramatically cutting their debt while expanding their 5G and fiber networks. Based just on the parts of the company the market assigns value to, I believe it is worth middle $20s per share now while it is trading in the teens.

But wait, there's more. The market is not assigning value to the potential for AT&T to use technology to continue to grow their business domestically and globally. I believe this is the type of situation that Charlie Munger talks about when looking for great values.

The short story is that AT&T is undervalued based on what everyone already should know, but could be dramatically undervalued based on what they don't know. I rate AT&T a strong buy for retirees, as well as, a buy for growth investors who want a lower risk dividend paying piece to fund purchases of other growth stocks over time.

AT&T Q1 Earnings Results

AT&T had over $120 billion in revenue in 2022. In Q1 their revenue was $30.1 billion which was a negligible quarterly Year-over-year 1.4% increase.

Consumer wireline continues to be a drag as customers leave by attrition (quite often death) or as they switch to cellular service only and/or use their broadband connection landline service.

Enterprise wireline is also suffering as businesses switch from expensive legacy systems to other services. This is where major margin compression has occurred.

Many of the consumer customers of course go full cell phone. Enterprises move to VOIP and cell combinations in many cases. In either situation, AT&T captures many, however, margins can become narrower, especially on the enterprise side.

In Q1, AT&T added 272,000 fiber customers, building their base to 6.3 million fiber customers, up 21% year-over-year.

Mobility, i.e., cell phones, is AT&T's largest revenue driver providing just shy of 70% of AT&T's revenues. Even in a price competitive market, AT&T grew their share of mobile business by 2.5% year-over-year.

It is easy to understand the known drives of AT&T's revenues here. Mobility, followed by fiber.

I rely on two outside services to breakdown balance sheets and do the forensic accounting for me. They aren't always right, but are generally pretty close. In addition, I have found when they agree it is pretty powerful or very scary.

In the case of AT&T, they both point out that AT&T's free cash flow appears to be understated as a result of the non-cash costs associated with disposing of assets, in particular DirecTV and Warner. That makes sense to me.

Also, we should remember that capex is high right now, but, in a pinch, such as a recession, can be dialed back substantially and rather quickly, at least temporarily. The takeaway here is that AT&T is running lean as a matter of course, and it looks worse than it is, but they can be nimble if they need to be.

In coming quarters, we will want to keep an eye on ROIC, that is, return on invested capital, to see if their capex spend is continuing to create positive returns, and in particular, positive returns that can overcome the wireline attrition.

AT&T Is Strongest Where They Offer Fiber

The growth of AT&T's fiber offerings is creating synergies for 5G customers. The ease of bundling to one bill are significant.

Indeed, the company's stated goal is to grow an integrated wireless and fiber network across America.

Part one of Margin of Safety Investment's investment selection approach is to identify secular trends. AT&T management has posited that 5G and fiber are a secular growth trend. I agree.

AT&T's 5G wireless network currently covers 160 million people in the U.S. and is headed to about 200 million by the end of 2023. Adding fiber at an increasing rate will bring more consumers and businesses in range of buying both services from AT&T.

How important is the synergy between fiber and 5G? So strong that AT&T and BlackRock ( BLK ) put together a joint venture for AT&T to offer fiber nationally outside of AT&T's current 21 state wireline footprint.

The partnership with BlackRock's Alternatives Diversified Infrastructure Fund is called Gigapower and will sell AT&T fiber through its nationwide wireless sales channel. That is, all those AT&T stores you see around.

If the synergies were weak between 5G and fiber, AT&T would focus on the 21 states they already have a footprint in. The two services are complimentary.

Expanding fiber is a way to cross sell products and services, which every salesperson knows is positive for retention. In mobile services, reducing churn is key to profitability. AT&T is doing what they can to make the 5G business stickier, as well as, growing fiber.

According to AT&T, the first customers have already been signed up and according to Fierce Telecom that seems to have been in Mesa, AZ. Also according to Fierce, there are deals with Mesa neighbors Gilbert and Chandler. Nevada is also on the immediate horizon where they will try to take CenturyLink business among others.

Because AT&T has cables almost everywhere in America, as well as, a sales force, the expansion of its fiber network has major advantages to competitors. But there is competition in Google Fiber ( GOOG ), Cox, Comcast ( CMCSA ) and CenturyLink ( LUMN ) and others, so AT&T will have to execute - not always their bailiwick.

Indeed, I expect some consolidation. Lumen seems ripe to be plucked up and Google is a natural suitor if the government allows it. Otherwise, Comcast has never been shy about deals. At this point though, it's hard to say how consolidation will look or how fast it will move. Ultimately though, that's good for corporate margins.

Because Gigapower is a JV, AT&T will not have to consolidate any debt onto its own balance sheet. There are some clear advantages to that.

Assuaging Your Debt Concerns

The number one excuse people have for not investing in AT&T is the debt.

AT&T finished Q1 with $137.5 billion in debt. However, that debt is well spread and is financed at a combined 4.1% per their recent earnings call and debt detail .

The company also used the Warner deal to reduce debt/EBITDA to a projected 2.5 by the end of this year from 3.22 to start the year, and higher prior to the Warner divestiture.

Most cash flow that AT&T generates is going towards capex and debt reduction.

This chart demonstrates how well spaced AT&T's debt is:

As you can see, relative to revenues and cash flows, there are no massive debt repayments due until the 2050s. By then, the company will certainly have used another low interest rate period to stretch those debts out.

The tightest AT&T appears to be on debt is in the next two years as they get past the $8 billion due in 2024. Cash flow will cover that, but, the company has indicated don't expect anything but tiny increases in the dividend. I am forecasting only 1% annual dividend growth long-term.

I would expect that to be true perpetually going forward. Why? The company has indicated that by 2025, they prefer to buy back shares to reduce what is going out on dividends in aggregate versus increasing the dividend.

So, for dividend investors, you will see small dividend increases, but buybacks starting in the next few years. Fewer shares outstanding reduces the dividends paid on aggregate, which is money that can go towards capex and debt reduction.

Currently, the cash dividend payout ratio is about 72%, though I expect that to fall back under 60% in the next few years as debt and capex both start to normalize.

The narratives of traders can be powerful for those who don't actually study the balance sheet, which is clearly over 80% of investors. I suggest you look at the numbers today because AT&T is doing well on debt reduction as they transition the company to tomorrow's business mix.

What The Market Is Missing With AT&T

Rather than completely regurgitate the earnings report, which is available by clicking here , I want to point out two potential revenue drivers that nobody is talking about that I can find besides me, hints from AT&T management and tech geeks online.

A Roku Competitor

The first is that I believe technology will allow AT&T to compete with Roku ( ROKU ) and Amazon Fire ( AMZN ) for being a platform to distribute streaming apps and content.

Consider how you buy your streaming apps. Do you buy from Roku, Amazon, Apple ( AAPL ) or directly? And, how do you figure out what is available to watch? It's all a bit of a hassle isn't it? What if it could all be simplified?

I believe that AT&T is in a prime position as a fiber company to create an "on the wire" service that is similar to Roku and Amazon Fire, but without any hardware. Think of it as a super robust version of the Discovery app which I think is the best one out there, or Netflix ( NFLX ) which almost everyone is familiar with.

If you could have a TV home screen that showed you your apps and a live TV schedule that included both local and the streaming services you are subscribed to, how cool would that be? AT&T should be able to do that and be able to consolidate your fees directly into your AT&T bill.

AT&T's earlier skirmishes with Roku seemed a harbinger to me a few years ago of coming competition from AT&T to Roku, and Amazon Fire. Admittedly, other than finding hints of such a product coming, I can find nothing concrete.

But, we know a few things. The technology appears to be ready or almost ready. And, when tech creates an opportunity to make money, that money usually gets made.

Next on the list for AT&T is even bigger.

AT&T Becomes A Global 5G Company

AT&T has a deal in place with AST SpaceMobile ( ASTS ) to provide its satellite 5G direct to handset service. What is this?

Currently, all 5G signals emanate from cell towers. However, there are dead spots all over America and problems during emergencies, such as hurricanes and after tornados. Perhaps why American Tower ( AMT ) bought 5% of AST SpaceMobile outstanding shares.

AST SpaceMobile is in the final phase of tweaking their technology before launching a fleet of satellites that will send 4G and 5G signals direct to cell phones. Unlike competitors, this is the only service that can beam direct to a cell phone without additional antennae and equipment.

How big would this be for AT&T? Most who are looking at this look at it as an incremental gain for AT&T. I see it as at least that and likely more.

There are the easy to understand applications for emergency and military services. FirstNet is a clear likely user of this service and that has already been discussed publicly. The DOD has also been in talks with AT&T.

General consumers would benefit as they travel through dead zones outside of cities and on water or in the air.

Here's where it gets even more interesting, and certainly there are plenty of regulatory hurdles, but AT&T in the next few years could become a global company with access to billions more customers. How so?

AST SpaceMobile's constellation, once fully deployed, will cover most of the surface of the earth. AST is going to start with equatorial coverage though and this includes about two billion people, largely in emerging markets.

How sure are we that AST SpaceMobile's tech will work and get deployed? All signs point in that direction.

• The test satellite is sending packets of data directly to handsets now. They are working to optimize.
• The FCC has been working with AST and AT&T, and last month started the process of proposing rules dubbed "supplemental coverage from space."
• The Mobile World congress is working on the same thing.

Clearly the regulators can see that 5G service from space is coming. Now it's a matter of regulation and implementation.

Here's a question I have been asking members of my service: If you lived in an emerging market and now could get 5G service through an AST SpaceMobile partner and AT&T was a choice, would you pick the American company? I think a lot of people would.

AT&T's challenge will be to get through the partnership and regulatory maze to make themselves an option globally. Will it be easy? No. Can it be done? Probably, and that's sort of their thing.

I Rate AT&T A Buy

As I stated in the introduction, I rate AT&T a buy based on the known knowns.

That the company is in transition and has a rocky past is what is causing an attractive value price to buy now.

The company is particularly attractive to retirees who want mailbox money in the form of a very well covered dividend from a utility like company.

I think retired investors who sold AT&T out of anger about the dividend cut are missing the boat by not getting back in now. The price is right, the business is better and the upside potential is there.

The kicker here is the potential for far more growth than anyone is factoring in right now. That's fair, but, I think clearly the potential for surprises with AT&T are positive now, post Warner spin off, versus negative.

The worst case in my opinion is the company chops along and pays the dividend.

The best case is that the company adds tens of billions to its annual revenues about the same time debt and capex are coming down in 3-5 years.

You can certainly argue the "I'll wait 'til I see it happening case" but by the time you see it more clearly, big value investors have probably bought shares. Frankly, I expect big accumulation in coming months.

Normally, I would have a cash-secured put sell to recommend, but there is virtually no time value being given at these prices. That typically means the bottom is roughly in. So, just buy AT&T shares.

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