AT&T: A Reasonable Dividend Holding

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Old Ma Bell has gotten a new lease on life. For many investors, AT&T, rather remarkably, has become a sexy growth company once again. Enthusiasm is building, and several commentators have labeled it a top pick or must own company.

Shares have been moving, albeit slowly, higher, and are now approaching new all time highs. The company is forecasting full-year earnings around $2.68 per share, leaving it at a modest 13 PE ratio. Ignore the financial data you see on investing websites, it fails to account for the company’s recent merger with DIRECTV.

On top of that 13 PE ratio, you get a starting 5.6% dividend yield, with another dividend hike expected shortly. The combination of low valuation, high dividend yield, and newly added growth kicker, to some, seems irresistible.

Let us take a look at the positives, and then consider the potential drawbacks. The growth story is built primarily around international expansion.
The Mexican government recently forced the country’s near-monopolistic telephone operator, America Movil, to allow more competition. America Movil, which currently controls 70% of the market, will be forced to cut its market share to 50% or less.

This creates opportunity, and AT&T has stepped into the gap, buying two regional players, and joining them to form a reasonably strong alternative to America Movil’s Telmex brand. The AT&T operation has roughly 8 million subscribers, not great out of a country with more than 100 million people, but the upstart network is growing rapidly. At least one analyst sees that 8 million person market expanding to 35 million, a fourfold increase, by the end of the decade.

AT&T also has a solid growth opportunity in the high speed internet space, where it currently only has 12.5 million active accounts. This, in combination with new DIRECTV and triple-play customers should allow for further growth in the United States that more than offsets the fall in the legacy landline business.

Additionally, AT&T has picked up some assets in Brazil as a result of the DIRECTV merger, giving it an entry into South America’s most populous nation. It is speculated that Brazil will attempt to make a bigger acquisition in Brazil to became a major player there.

On the downside, AT&T faces significant obstacles as well. For one, the core landline business is still a major portion of the business. It has been riding that cash cow for decades. The bulls can point to the fact that the rate of landline decline has shrunk, it was falling 15% year to year, and the decline rate is down to about 8% a year. Still, 8% annual drops in a core business segment are a strong headwind.

The company’s other big core line, the wireless telephony business, appears to have reached saturation. There aren’t many more new customers to acquire in the United States that don’t yet have a mobile phone. And while there will always be churn from one company to another, it seems unlikely AT&T will steal large numbers of customers from Verizon and the others. If anything, the smaller cheaper upstarts may steal a couple points of share.

The Mexico expansion is a legitimately exciting opportunity. It could offer great upside for the company. However it’s no slam dunk assured of success.

AT&T is up against America Movil, run by Carlos Slim, one of the world’s richest men. Slim has spent decades building his fortune, empire, and perhaps most importantly, connections. Sure, the Mexican government is saying the right things about more competition, but when the rubber hits the road, you can expect America Movil to get the homefield advantage in any contested political decisions against foreign AT&T.

It’s also likely that prices will fall in Mexico for telephone services. America Movil had abnormally high prices, due to its near monopoly status. The addition of competition, while allowing AT&T to steal customers, is likely to drive prices much lower, eroding margins.

The Brazilian economy is in deep trouble, hurting the profitability outlook for AT&T’s operations there. And it appears the Brazilian government may attempt to block AT&T if it makes a play on one of the country’s bigger wireless operations.

Overall, AT&T is in reasonably good shape and position for a utility. The dividend is generous at almost 6%. The PE ratio, 13, suggest a cheap company.

However the growth story seems a lot cloudier than the bulls are saying. If you want a slow-growing company that pays a dependable high yield, AT&T is a good choice. But this old dog hasn’t learned a new trick, the stock price isn’t going to start flying higher anytime soon.

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