As virus fears hit the stock market again, AT&T (T) is headed to wash-out levels seen back at the market lows in mid-March. The stock is now below $28 and offers a smashingly large 7.5% dividend yield. My investment thesis has been less enthusiastic about the company recently, but the valuation is too appealing when the market turns extremely bearish on the stock in the middle of a market sell-off.
Image Source: AT&T website
Historical High Yield
The COVID-19 shutdown hit AT&T hard. The cable television business continues to see cord cutting and wireless customers weren’t able to pay. A second wave of the virus just isn’t as likely to hit the stock as hard with live sports remaining active this time around and most dire economic shutdowns avoided.
The company has already taken a free cash flow hit of at least $3 billion this year. AT&T has an updated FCF estimate for 2020 of only $25 billion at a 60% payout ratio. In addition, the wireless and media giant had goals of growing FCF to $31 billion by 2022.
Despite the FCF hits, the dividend remains easily covered in this environment with ~$15 billion in annual payouts. The dividend yield remains at the highest levels in the last decade as the previous highs were hardly ever above 6.0% until the wireless giant took on the large debt to acquire Time Warner.
At a 7.5% yield, AT&T only needs to trade flat in order for investors to generate solid total returns going forward. The company appears to be actually making the wiser moves here with Verizon Communications (VZ) buying Tracfone for up to $6.9 billion.
Due to Verizon trading near the post-2000 highs near $60 here, the dividend spread with AT&T is the highest in history. AT&T now offers a yield of 3.25 percentage points higher than the 4.2% dividend yield of Verizon. Historically, the yield was within 1 percentage point of each other suggesting AT&T should have a dividend yield down around 5.2% to remain in line with where Verizon trades.
AT&T is busy paying off debt while Verizon just took on a $3.125 billion cash payout with the potential for another $650 million in earn-outs. The charts show a clear pattern of separation when AT&T took on debt during 2018 to acquire Time Warner.
The key to success is AT&T following the plan of repaying debt while Verizon is now making the deals requiring a build in net debt. The market could clearly shift into AT&T this cycle with new leadership at HBO, if the company sticks to plans of avoiding debt-fueled acquisitions.
Even the depleted free cash flow levels still leave the wireless and media giant with up to $10 billion in cash to pay down debt after paying the hefty dividend. AT&T isn’t in such dire straits to warrant the constant stock dips.
AT&T reached a low of $26.08 during the market crash in March and another run down to these levels would completely wash out the stock again. The inevitable double bottom here is a definite buying opportunity with the dividend yield reaching nearly 8.0% at the lows.
Down at $26, a shareholder only needs the stock to rally back to $32 to generate an annual return of over 30%. One shouldn’t really expect AT&T to rally back to the pre-virus highs around $38 to $40, but the possibility always exists. More importantly, rallies back to these levels will generate the following solid annual total returns:
- $29.60 – 18%
- $32.20 – 28%
- $35.80 – 38%
Of course, any timeline less than a year wouldn’t generate the full 8.0% dividend yield, but investors would see substantial upside with limited risk here. With the large-cap tech stocks still trading at extreme valuations, AT&T at only 9x forward EPS estimates offers deep value.
The key investor takeaway is that AT&T clearly hits very cheap levels on any further wash-out nearly $2 lower here. The stock already offers a historical spread with the Verizon dividend and the recent deal could push investors back into AT&T. When the stock dips to $26, investors should have their sights on a low risk 30% return from the wireless and media giant.
If you’d like to learn more about how to best position yourself for a rally in beaten-down stocks due to COVID-19, consider joining Out Fox The Street.
The service offers a model portfolio, daily updates, trade alerts and real-time chat. Sign up now for access to legacy pricing available to the next few subscribers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.