I’ll be blunt: I hate AT&T (NYSE:T).
But before you chime in with an enthusiastic “me too,” I’m not referring to AT&T’s mobile phone service or home internet service (both of which I dumped years ago for being overpriced).
I’m talking about AT&T stock. Though to be fair, I’m not any more fond of Verizon, Vodafon or any of the other large telecom stocks.
As you might know, I’m Dent Research’s “income guy.” I focus on retirement issues and income stocks in my Peak Income newsletter.
Given that I recommend high-yield stocks, you might assume that high-yielding telcos like AT&T – especially with its merger with Time Warner (slowly) pushing forward – would be right up my alley.
AT&T sports a dividend yield of 6.1%, making it one of the highest-yielding stocks in the S&P 500. It’s also raised its dividend for 34 consecutive years and counting. That’s not a bad run.
So, if it pays a nice dividend and has a history of raising it… what’s not to like?
Let’s start by listing a few criteria I like to see in a dividend stock:
- The company should have competitive “moats” around it that protect it from competition. Companies in low-margin, hyper-competitive industries tend to be risky payers that cut their dividends when times get tough.
- The company should also be “future proof,” or as close to future proof as possible. You don’t want its business model disrupted by new technology.
- Demand for the underlying products should be growing or at least very stable.
- The company should pay out a relatively low percentage of its earnings as dividends. This gives the company a cushion in the event that earnings fall a little short one year. (Certain stocks, such as MLPs and REITs, are exceptions to this rule. Tax laws require them to pay out substantially all of their net income, and depreciation and other non-cash expenses tend to skew the numbers and make them hard to compare.)
So, how does AT&T stack up?
Well, to start, AT&T has nothing in the way of competitive moats. Not only does the castle lack a moat, the guards left the drawbridge down and left for lunch.
You can change mobile carriers in a matter of minutes now, and contracts are less of an impediment to leaving than they were in the past. Led by T-Mobile, virtually every carrier now advertises no-contract plans.
And its not just mobile phones. These days, it’s generally pretty cheap and easy to change your cable TV or home internet provider. So whatever moats AT&T might have enjoyed a decade or two ago have long since dried up.
Is AT&T future proof?
Much of AT&T’s infrastructure consists of legacy copper wiring originally used for landline phones, and the company constantly is upgrading its mobile network to stay competitive. AT&T is stuck on a technology treadmill, and it has to keep running… or risk getting thrown off.
But isn’t demand for its services rising, at least? Yes and no.
Yes, we all use more data today than we did a few years ago, and that trend isn’t likely to reverse any time soon.
But the smartphone market is now saturated in every developed country and not far from saturation in many emerging markets.
Everyone already has a smartphone. So, the only way to gain market share is to poach customers from another carrier, which means lowering the price and offering incentives… both of which lower margins.
So, while demand for service (particularly data) is growing, that growth is not leading to higher revenues or profits. And that’s just mobile data.
Home internet is a saturated market, and paid TV is actually shrinking due to cord cutting. All of AT&T’s businesses are mature, no-growth businesses at this point.
But the dividend payout ratio is low, right?
AT&T’s dividend payout ratio looks low, at 40%. But this headline number misses the fact that net income was inflated last year due to corporate tax cuts passed in December.
AT&T realized a $20 billion extraordinary tax benefit, which will not be repeated.
Between 2014 and 2016, the payout ratio averaged 107%, meaning the company paid out more than it was earning.
Lower tax rates going forward will help, of course. But in the first quarter of this year, the payout ratio was 67%.
That’s not a range that puts the company at immediate risk of cutting the dividend, of course.
But in order for AT&T to safely raise it from here, they need growth. And free cash flow has barely budged over the past decade.
AT&T changed its business model by merging with content creator Time Warner, the parent of HBO, CNN and a host of other networks.
But given the glut of content these days and the unrelenting competition from Netflix, Amazon, and other up-and-coming creators, its’s hard to see this being the growth vehicle AT&T needs.
And all of this assumes the government doesn’t torpedo the deal, which it has indicated it intends to do.
Bottom line, don’t expect to see AT&T in my Peak Income portfolio any time soon. We can do better.
Incidentally, I’ll be speaking at Dent Research’s annual Irrational Economic Summit October 25th to 27th in Austin, Texas, and I’ll be giving my thoughts the best places to hunt for income in this environment.
I’ll share some of my favorite investments… and, like I am today, I’ll tell you which ones – like AT&T – to avoid.
Apart from speaking, I’ll also be making the rounds, talking to the attendees. If you want to pick my brain or just enjoy a beer with me, this is a good chance.
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