That the world is going digital isn't a fact that will shock anyone. And American Tower's (AMT 0.58%) cell towers have benefited greatly from the technology trends as more and more of the world's digital activity takes place on wireless devices like smartphones. However, if the company's own guidance is any indication, there's no need for investors to rush to buy its stock.
A big drop
American Tower's stock peaked in 2021 and is now roughly 33% below that high-water mark. In fairness, even after that decline, the stock is still up over 150% over the past decade, but it's still a painful drop. Things start to get more interesting when you consider its huge 20% annualized dividend growth over that decade. In fact, the recent stock price declines have pushed its dividend yield up to historically high levels.
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That's the type of story that should interest long-term dividend investors. However, there's more to understand here. For starters, American Tower is a real estate investment trust (REIT). It owns cellular towers and some data centers, and it remains well-positioned to support the trend toward increasing digitization and mobile data usage.
And yet there are some legitimate reasons to think that, maybe, there's no need to jump in right away. Its heavy focus on one industry might be enough to keep conservative investors who prize portfolio diversification away. But the real problem is that American Tower's management team has painted a pretty weak outlook for its near-term future, at least financially speaking.
The trends aren't all your friend
While American Tower sees no near-term end in sight to the growth in demand for cellular towers, driven by increasing data usage, it sees a major headwind in another number that is heading higher: the benchmark federal funds interest rate.
As a REIT, American Tower is legally obligated to pay out 90% of its taxable income each year in the form of dividends. That leaves it with little to fund capital spending or make acquisitions, the two key ways a company can grow. So when it has material capital needs, it has to either sell stock or issue debt. That's not unusual: All property REITs largely face the same issue.
That said, American Tower has been specific about the headwind it faces as its debt costs rise along with interest rates. In 2023, higher debt financing costs are expected to be a $315 million drag on its bottom line. That's the primary reason why the REIT expects its adjusted funds from operations (FFO) to fall by 2% in 2023 from 2022 levels.
But neither of those figures does the issue justice. According to the company's fourth-quarter update, for this year, it predicts "Strong Cash Adjusted EBITDA growth conversions driving ~9% growth absent financing costs, FX and VIL reserves." However, it also said that financing costs are expected to reduce its adjusted FFO growth by approximately 8 percentage points, "primarily driven by rapid rise in interest rates and associated impacts on floating rate debt." Essentially, higher interest costs alone are going to eat up virtually all of the business growth the company expects in 2023.
Meanwhile, the 3.2% yield, while high historically, is actually below the average for REITs, using Vanguard Real Estate Index ETF and its 3.5% yield as an industry proxy. You might even be able to get a higher interest rate from a bank CD today. The strong historical dividend growth here is the big offset, but how fast can an investor expect the dividend to grow in the near term if adjusted FFO is going to decline in 2023? Likely by much less than the historical trends might suggest is a realistic directional guess.
On the radar
American Tower is not a bad REIT. In fact, if history is any guide, it is a pretty well-managed one. However, management is clearly telling investors not to expect its performance in 2023 to be on par with its historical performance, and so long as interest rates keep rising, that will likely remain the case. Investors interested in the stock after its steep price drop should probably keep it on their radar, but perhaps buying it right now isn't the best plan. That said, when the Federal Reserve announces that its fight against inflation is over, it might be time to revisit the story.
