The stock market has gotten off to a rough start this year, with the S&P 500 falling nearly 10% by Jan. 20 before slightly recovering. Yet telecom giant AT&T (NYSE:T) quietly rose 2% since the beginning of the year as investors panicked. Although AT&T shares weren't affected by the recent market sell-off, I added more shares to my position, which I started last November. Here are my three main reasons for doing so.
1. Big dividends
As an income investor, I mainly bought AT&T was its dividend. AT&T's 5.7% yield is slightly higher than Verizon's (NYSE:VZ) 5.1% yield, as well as the S&P 500's average yield of 2.3%. AT&T is also a "dividend aristocrat" that has raised its dividend annually for over three decades.
Over the past 12 months, AT&T paid out 69% of its free cash flow as dividends, while Verizon paid out 76%. So AT&T has slightly more room to grow its dividends. But on an EPS basis, AT&T paid out nearly 200% of its earnings as dividends, compared with just 89% for Verizon. That big gap between AT&T's FCF and EPS payout ratios was caused by its $49 billion acquisition of DirecTV. But looking ahead, AT&T expects its FCF, earnings growth, and payout ratios to all stabilize as the acquisition becomes earnings accretive within the first year.
2. Low valuations and great FCF
AT&T stock initially looks expensive at 37 times earnings, which is nearly double Verizon's P/E of 19 and the industry average of 18. But looking ahead, AT&T's forward P/E drops to 13, thanks to the completion of the DirecTV deal. AT&T expects "$2.5 billion or better in annual run rate cost synergies" from that acquisition to significantly boost its bottom-line growth through 2018.
AT&T has a price-to-FCF ratio of just 13.5, while Verizon has a higher ratio of 17.2. This means AT&T is cheaper than Verizon based on its FCF, which will be bolstered by DirecTV. AT&T also expects its FCF to rise 50% annually to $15 billion for fiscal 2015. That's a lot of cash that can be spent on dividends, buybacks, investments, acquisitions, or paying off debt in the coming year.
3. Diversification and growth
AT&T is also more geographically diversified than Verizon, which generates most of its revenue from the United States. AT&T's overseas operations include wireless services in Mexico and satellite entertainment services in Latin America.
AT&T believes that its number of 4G subscribers in Mexico will rise from 29 million at the end of the third quarter to 40 million by the end of the year. According to eMarketer, only 60% (62.5 million) of Mexico's mobile users used smartphones as of last October, while the rest used feature phones. AT&T's user base will grow as more of those users upgrade to 4G smartphones.
The rest of Latin America, where demand for pay TV services is rising, is a fertile growth market for DirecTV. Last quarter, AT&T noted that the unit was posting "solid growth on a local currency basis" across the region, although currency impacts still weighed down its revenues, average revenues per users, and margins. But when Latin American currencies finally stabilize and the dollar weakens, those numbers should improve.
AT&T is also tethering its network to the Internet of Things, which consists of wearables, connected cars, smart home appliances, and other everyday objects. To support that growth, the company is expanding its high-speed fiber network to dozens of new cities. All these moves could eventually generate fresh streams of revenue for the company.
Is AT&T right for you?
Investors who are looking for stocks with explosive price growth definitely won't like AT&T. But investors who are looking for a solid defensive stock that pays a generous dividend should take a closer look. In the near term, AT&T remains well insulated from concerns about oil and China, and DirecTV's growth potential in Latin America outweighs the unit's near-term currency headwinds.