AT&T Stock: You Need Total Shareholder Return, Not Dividends (NYSE:T)

Stock T: Prior Thesis and Total Shareholder Return

I recently wrote an article titled “AT&T Q2: Catalysts Galore” about AT&T stock (NYSE:T) stock. Posted on July 27, 2024 This piece analyzed the company’s second quarter earnings report, as you can already says the title. In particular, we highlighted several factors that could support an optimistic investment case, despite some unevenness in its performance in the second quarter. Quote:

Overall, I see far more positives than negatives from the T2 report. I see plenty of earnings catalysts to drive EPS growth in the coming years. To reiterate, top on my list are stabilizing CAPEX (and subsequent FCF growth potential), growing its fiber network, and the many synergistic opportunities between fiber and its other segments.

So that article covered a wide range of subjects with a broader outline. After reading the recent articles about this stock, I thought it would be useful to focus this article on one thing – its dividends. As a manual dividend stock, T’s generous dividend payouts are a factor behind many bulls’ thesis (and some bear’s thesis that the high dividend yield isn’t enough). However, the cash dividend is only one way that companies can return capital to shareholders. As such, I urge investors, especially dividend investors, to look beyond cash dividends and look at total shareholder return (TSY). TSY includes, of course, cash dividends, but also net share buybacks and debt repayments.

In the rest of this article, I’ll explain why its high dividend yield (currently 5.6%) understates its growth potential when TSY is taken into account.

T stock: stock buybacks in focus

Let me start with stock buybacks, the following chart below from a Morgan Stanley study shows overall stock buyback statistics for Russell 3000 companies ranked by size by decile. The observations in these charts are twofold, which are cited and summarized below. The second one (highlighted me) is particularly relevant here for T in my view.

Companies in the lowest three deciles achieved an average dilution of six percent, while the top three deciles collectively withdrew equity. Share buybacks are a way to return capital to shareholders that is equivalent to dividends under strict assumptions.20 But unlike dividends, which treat all shareholders equally, redemptions that occur at any price other than fair value result in a transfer of wealth. A company that buys back undervalued stock transfers wealth from the selling shareholders to the ongoing holders. And companies that buy back overvalued stock transfer wealth from holding shareholders to selling shareholders.

First, the largest companies tend to be net buyers of their own stock. And that’s what happened to T from its WarnerMedia spinoff. The spinoff has drastically improved its capital allocation flexibility (more on that later), and the company now has the wherewithal to afford buybacks. More specifically, the following cash statements show the issuance of common shares and repurchases of common shares in the most recent quarters (after the spinoff). As seen, the company focused primarily on buying back shares rather than issuing new ones during this period. In each reporting period, redemptions exceeded new issuance.

I will argue later that, as the Morgan Stanley report above points out, these buybacks are very likely to result in a transfer of wealth from sellers to buyers under current conditions.

Stock T: Debt Payment Discounts

Before I dive into wealth transfer, I need to examine the last part of TSY: debt payments. The chart below shows the repaid debt and other liabilities for T shares from the WarnerMedia spinoff. As seen, T consistently paid his debt during this period. As a result, long-term debt and total debt have been on a downward trend recently – a fairly rapid one I’d call it. For example, in December 2021, total liabilities stood at $367 billion+, and by March 2024, the figure had fallen to $276 billion. The biggest driver for the lower total liabilities is the reduction of its long-term debt. As seen, its long-term debt has fallen from over $149 billion in December 2021 to the current level of $126 billion.

I will further argue that such debt payments made the company more attractive to shareholders (i.e., existing shareholders), as did cash dividends.

Stock T: Valuation discounts

A reduction in debt translates directly into a lower EV (enterprise value) all else being equal, and thus makes the company’s valuation more attractive – if you look at the stock from the perspective of a business owner (or a buyer looking to buy the whole company). Specific to T, commonly quoted P/E ratios thus underestimate its attractiveness because they ignore the debt component. As seen, T’s current P/E ratios, on either a TTM or FWD basis, are significantly below the sector median but above the 5-year average. For example, the P/E (TTM) is 8.59x compared to the sector median of 12.24 (representing a difference of -29.84%), but about 11% above the 5-year average of 7.75x.

If we switch to EV-based metrics to include the impact of debt reduction, the picture changes substantially. As also seen in the chart below, T’s EV-based multiples such as EV/EBITDA or EV/EBIT ratios are currently both substantially below the sector median and below its own 5-year average by a good margin. For example, FWD’s current EV/EBIT ratio is 12.66x, compared to the sector median of 15.15x (representing a discount of 14.47%) and its 5-year average of 13.94x (representing a discount of over 9%).

When shares are bought back at such discounts, as the Morgan Stanley report above pointed out, I see a good chance for a transfer of wealth from existing shareholders to downstream shareholders.

Other risks and final thoughts

In terms of downside risks, T shares most of the risks common to the telecommunications sector and also faces some more specific risks. Common risks include intense competition, rapid technological advancements, regulatory risks, high CAPEX requirements, etc. The telecommunications market is highly competitive, with both established companies such as T and new entrants competing for market share through price wars, bundled services and innovative offerings. . Additionally, to remain competitive in a rapidly evolving technology landscape, these companies need to spend heavily on CAPEX (such as rolling out 5G networks and potentially investing in AI-related features). As a more specific risk for T, its vast legacy network of cables (some of which are lead cables) may expose the company to environmental regulatory and legal risks. For example, the Environmental Protection Agency (EPA) recently investigated the environmental and health risks these cables posed. As an offshoot of these investigations, a shareholder lawsuit was recently filed against AT&T, alleging that the board and other top executives knew about the environmental risks the cables posed. These investigations/lawsuits could lead to financial impacts for T and also violent stock price volatility.

Overall, my conclusion is that the market has already priced in all the negatives, but is likely to underestimate the positives. In particular, the dividend yield—a point emphasized by many T-bulls—underrepresents the stock’s TSY as the company moves from stock dilution to dilution—at discounted valuation multiples—and aggressively pays down its debt.