There's a good chance that you couldn't function without a cellphone (you might even be reading this article on one). But your cellphone wouldn't work if there weren't companies like real estate investment trust (REIT) American Tower (AMT -0.70%). It owns the communication sites on which cell towers are located. In addition to 13 years of annual dividend increases and a 17% dividend growth rate over the past decade, dividend growth investors will also want to understand the leverage built into the REIT's business model as they consider buying the stock.
A strong record
You can probably buy a certificate of deposit (CD) today that yields around 5% or so. That makes American Tower's roughly 3.2% dividend yield look a little skimpy. But there's something important that you are giving up when you buy a CD -- dividend growth. With a CD, you basically collect a static interest rate and then get your cash back at the end. With inflation running hot today, that's not such a compelling deal. And if rates are lower when the CD matures, you'll have to reinvest in a new CD with a lower rate, meaning you'll earn less interest.
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American Tower's 13 years of dividend growth allow you to keep up with inflation. The fact that the dividend has increased at a 17% annualized rate over the past decade means your actual buying power has grown materially over that span. Although REITs are often considered slow and steady growers that offer high yields, this particular landlord turns that equation on its head to some degree. It has a modest yield and rapid dividend growth.
The reason for that is the vital nature of its properties in what has become an increasingly important part of the global telecommunications infrastructure system. With more and more people moving permanently to cellular phones and doing more and more data-intensive things with those devices, demand for the properties that American Tower owns has been huge. In addition, it has been using its scale to spread its reach into newly developed and emerging markets, further fostering long-term growth. That big-picture take, however, glosses over something important that investors need to understand.
High returns
From a technological standpoint, a cellular tower isn't all that exciting. It's just a galvanized steel structure sitting on what is generally a small, though usually well-located, land parcel. That's all American Tower owns. All the high-tech stuff, like antennas and communication equipment, is owned by the REIT's tenants. And, notably, the tenants are responsible for maintaining all of that equipment, so the day-to-day costs for American Tower are pretty modest.
Things start to get more interesting, however, when you consider the way in which the company's towers get leased to communications companies like Verizon, AT&T, America Movil (Latin America), Telefonica (Europe), Airtel (Africa), and Bharti Airtel (Asia). It isn't just one tower to one provider. Very often, American Tower has a one-to-many relationship. The difference between them can be huge.
For example, according to the REIT, a single tower costs around $275,000 to build. With one tenant, that tower brings in roughly $20,000 in rent with operating costs of $12,000 for a gross profit margin of $8,000 or about 40%. If American Tower adds a second tenant, there's no additional construction cost, and operating costs only rise to $13,000. But it can bring in as much as $50,000 in rent. That increases the gross profit margin to $37,000 or about 74%! Adding a third tenant leads to costs increasing to $14,000 and rents jumping to as much as $80,000. The gross profit margin increases to $66,000 or 86%.
The biggest jump comes from the second tenant. But with little to no extra cost involved with the second and third tenants, the real story is the massive increase in profit margin that occurs. One tenant produces a respectable gross profit margin of 40% but three more than doubles that figure! When you understand the built-in leverage of the business, you can see how the REIT has been able to grow adjusted funds from operations (FFO) at a compound annualized rate of 12.4% over the past decade.
An attractive opportunity
American Tower's shares have fallen roughly 30% from their 2021 highs. That's pushed the yield up to 3.2%, which isn't huge on an absolute basis but is actually near the highest levels in the REIT's history. If you are a dividend growth investor, this stock, backed by a highly attractive business model, looks like it is in bargain territory today.
