The Dividend Aristocrats are among the highest-quality dividend growth stocks. Investors looking for dividend growth would be wise to review the list, which is made up of 51 stocks in the S&P 500 Index, with at least 25+ consecutive years of dividend increases.

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Every year, we analyze each of the Dividend Aristocrats in detail. This year’s edition begins with telecommunications giant AT&T (T), which has increased its dividend for 33 years in a row.

Not only that, but it also has the highest dividend yield of all the Dividend Aristocrats. AT&T is one of 397 dividend stocks with a 5%+ yields You can see Sure Dividend’s full list of established 5%+ yielding stocks here.

This article will discuss why AT&T is one of the most attractive Dividend Aristocrats for income investors.

Business Overview

AT&T is one of the largest providers of cable and satellite TV, wireless, and broadband service in the U.S. It has a market capitalization of $241 billion. In 2016, AT&T’s revenue increased 12%, to $168 billion. Revenue growth was due to a combination of organic growth, as well as growth from the previous acquisition of DirecTV. Adjusted earnings-per-share increased 5%, to $2.48.

The benefits of the DirecTV acquisition are clear. AT&T has not only added subscribers and new revenue, but it also has seen lower churn.

Dividend Aristocrats AT&T

Source: Q2 Earnings Presentation, page 5

What makes telecoms like AT&T such impressive dividend stocks, is that they generate huge amounts of free cash flow. They are highly profitable and can increase prices. This provides high levels of cash flow, which telecoms return to shareholders through dividends. AT&T generated $17 billion of free cash flow in 2016.

But, pricing power often invites competition from under-cutters. This is going on right now, particularly when it comes to the wireless industry. Competition is heating up in the U.S. telecom industry. Low-priced competitors like T-Mobile USA (TMUS) are taking market share by under-cutting the industry giants. T-Mobile offers unlimited data plans at lower prices, which caused Verizon (VZ) to offer its own unlimited data plan.

Competition is fierce, which has made it difficult to grow organically. As a result, AT&T’s most significant growth catalyst moving forward, is M&A.

Growth Prospects

The telecom industry is changing. Major telecommunications companies are making a big push into media, to have the ability to own content and the distribution of it. Major deals that have come to pass include Comcast (CMCSA) acquiring the remaining 49% of NBCUniversal it didn’t already own, for $16.7 billion. Comcast also acquired Dreamworks for $3.8 billion, in 2016.

AT&T is following suit. It has reached an agreement to buy Time Warner (TWX) in a massive, $85 billion deal. This will give AT&T cable and premium networks including TNT, TBS, CNN, HBO, and Cinemax. It also owns the Warner Bros. movie studio.

Dividend Aristocrats AT&T

Source: Time Warner Acquisition Presentation, page 6

Assuming the deal is approved, AT&T would have approximately 144 million mobile customers, and 45 million video subscribers, around the world. By owning content and the technology on which it is delivered, AT&T can leverage its competitive advantages. It diversifies AT&T’s revenue mix, and accelerates growth. In addition, as a provider and a buyer of content, adding Time Warner is a hedge against rising costs for content.

AT&T expects the Time Warner deal to close by the end of the year. Overall, AT&T expects earnings growth in the mid-single digits for 2017. Free cash flow is expected to increase 7% from 2016, which should allow the company to continue increasing its dividend.

Competitive Advantages & Recession Performance

One of the most important competitive advantages for AT&T is its network. It has invested billions to develop its network, which helps differentiate it from the competition. AT&T spent more than $140 billion on its network from 2002 to 2016, including spectrum acquisitions.

Because of these investments, AT&T is at the top of the U.S. telecom industry, along with Verizon, arguably the only telecom that can compete on the same scale as AT&T. The concentration of the telecom industry helps drive AT&T’s high profitability.

AT&T remained profitable, even during the Great Recession. AT&T’s earnings-per-share during the Great Recession are as follows:

  • 2007 earnings-per-share of $2.76
  • 2008 earnings-per-share of $2.16 (22% decline)
  • 2009 earnings-per-share of $2.12 (1.8% decline)
  • 2010 earnings-per-share of $2.29 (8% increase)

AT&T’s earnings-per-share declined during the Great Recession, which should be expected. Discretionary expenses like cable TV are one of the things consumers may cut out of their budgets when the economy goes into recession.

That said, AT&T remained highly profitable during the recession, and returned to growth in 2010. This allowed it to continue raising its dividend each year.

Valuation & Expected Returns

Many finance web sites show AT&T with a price-to-earnings ratio of 18-19. In terms of GAAP earnings, this is accurate, but AT&T has incurred a number of non-recurring charges to earnings-per-share. Since these charges are expected to be one-time items, it may be more useful to evaluate AT&T in terms of its adjusted earnings-per-share.

Based on 2016 adjusted earnings-per-share of $2.48, AT&T stock trades for a price-to-earnings ratio of 15.8. This is a fairly low price-to-earnings ratio, considering the S&P 500 Index has an average price-to-earnings ratio of 25. AT&T could be slightly undervalued.

AT&T’s total returns will be generated from earnings growth and dividends. A breakdown of potential returns is as follows:

  • 2%-4% revenue growth
  • 1% margin expansion
  • 5% dividend yield

In this scenario, AT&T’s total returns would reach 8%-10% per year. Not surprisingly, AT&T’s dividend will constitute a substantial portion of total returns. AT&T distributed approximately two-thirds of free cash flow in shareholder dividends in 2016. The dividend payout appears to be secure, with room for modest increases going forward.

Final Thoughts

AT&T has nearly all the qualities income investors should look for. It is highly profitable, generates a lot of cash flow, and pays a secure 5% dividend yield. The lingering issue for AT&T is the heightened level of competition in the wireless industry, which shows no signs of slowing down.

However, AT&T’s long-term future remains bright. It has the scale and financial strength to outlast the competition. New technologies set to roll out next year, such as 5G, should help reestablish AT&T’s competitive position. Overall, AT&T is a high-quality Dividend Aristocrat, and a natural selection for investors seeking high income.

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Article by Bob Ciura, Sure Dividend