AT&T and Verizon Communications Inc. (NYSE:VZ) alone have more than 60% of the United States Telecommunications market. Sprint Corp (NYSE:S) and T-Mobile US Inc (NASDAQ:TMUS) together have another 30% market share.
There are 3 main reasons why the telecommunications industry lends itself to a few, mega cap corporations:
1. High up-front costs of building infrastructure
2. Expensive wireless spectrum usage costs
3. Brand recognition and scale advantages
Wireless spectrum usage is controlled and auctioned by the United States government. AT&T spent $18.2 billion in the last spectrum auction. In total, the auction raised $44.9 billion for the FCC. The next auction will begin in March of 2016.
With auctions measured in billions of dollars, entrance into the wireless market in the United States is severely restricted. There just aren’t any startups that can throw billions of dollars around.
AT&T’s large network, well-known brand, and ability to pay tremendous sums in spectrum auctions give it a strong competitive advantage.
The company is more similar to a utility than most other dividend growth stocks due to the subscription based model of wireless.
AT&T Inc. (NYSE:T) regularly pays out around 70% of its profits as dividends. This aligns shareholder interests with management as most cash flows are distributed directly to shareholders.
The money that is reinvested back into the business must be scrutinized carefully to invest in only the best growth projects.
With a 5%+ dividend yield, AT&T does not need to deliver rapid earnings-per-share growth to give shareholders above average expected total returns.
The company’s management is expecting long term earnings-per-share growth of between 4% to 6% a year. AT&T’s earnings growth plans revolve around key recent acquisitions:
– DirecTV
– Nextel Mexico
– Lusacell (a Mexican wireless provider)
Financial details of these acquisitions are shown in the image below.
Source: AT&T 2015 Analyst Presentation, slides 39 and 42
AT&T’s plan to expand into Mexico is the logical ‘next step’ geographically. The company is investing $3 billion to extend its high-speed mobile internet to 100 million Mexican consumers by 2018.
Customers on AT&T Mexico plans will be able to make calls on their Mexican plan while in the United States to others on AT&T plans. This ‘2 countries, 1 plan’ approach should have wide appeal in Mexico and for Mexican immigrants to the United States.
AT&T’s DirecTV acquisition will expand the company’s offerings. The strategic rationale behind the DirecTV acquisition is to expand digital content distribution. As a bonus, it also gives AT&T better cross-selling opportunities and cost-cutting possibilities.
It is likely AT&T’s management hits its 4% to 6% a year earnings-per-share growth estimate.
This growth combined with the company’s current 5+% dividend yield gives investors expected total returns of 9% to 11% a year from AT&T.
AT&T stock is trading for a price-to-earnings ratio under 14. Telecommunications stocks have historically traded for low price-to-earnings ratios which reflects there lower-than-average growth. AT&T is likely either fairly valued or somewhat undervalued at current prices.
The number of funds with long positions in AT&T (among the funds tracked by Insider Monkey) dropped by 12 to 48 during the fourth quarter of 2015, while the aggregate value of their positions declined to $3.10 billion from $3.76 billion and represented just 1.50% of AT&T’s outstanding stock at the end of last year. With its 46.58 million shares, Berkshire is by far the largest shareholders of AT&T on the Insider Monkey list, followed by Phill Gross And Robert Atchinson’s Adage Capital Management with 9.65 million shares.
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Final Thoughts
Warren Buffet has invested 20% of his portfolio in Dividend Aristocrat stocks. The percentage of his portfolio in the 4 Dividend Aristocrats outlined in this article is shown below:
– Coca-Cola makes up 13% of Warren Buffett’s portfolio
– Procter & Gamble makes up 3.2% of Warren Buffett’s portfolio
– Wal-Mart makes up 2.6% of Warren Buffett’s portfolio
– AT&T makes up 1.2% of Warren Buffett’s portfolio
Warren Buffett’s investing success shows that investing in high quality businesses trading at fair or better prices for the long run can produce very favorable results.
Disclosure: None
