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Buy AT&T for a Steady Dividend Income

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We believe that current fall in AT&T (NYSE: T) is a good buying opportunity for the investors who want to own dividend stocks. At the current levels, the stock offers an attractive dividend yield of 5.73%. The stock is also likely to show capital appreciation in the long-term. Therefore, we recommend a long position in AT&T at the current levels.

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Key takeaways

  1. AT&T’s sharp slide offers an attractive entry opportunity in a dividend aristocrat
  2. AT&T and Time Warner deal is likely to be delayed, but should go through
  3. AT&T’s debt is a concern
  4. For the near to medium-term, the dividend raises should continue

The stock is down about 20% year-to-date. Such a fall, especially in a dividend aristocrat, is because of concerns on the continuation of dividend payouts. Therefore, let’s analyze the stock’s financials and its business to determine whether it’s a value trap or an attractive buying opportunity at the current levels.

Dividend paying history of AT&T

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Dividend Aristocrats are companies that have increased payouts for 25 consecutive years. AT&T is part of that distinguished list, as it has increased dividends for 33 straight years. It managed to keep its record intact even during the dotcom bubble and the financial crisis, which gives us confidence. Until the situation turns grim, the company will continue raising its dividend and retain its name in the distinguished list.

Well, if it is such a no brainer, the price of the stock shouldn’t have plunged. There must be certain concerns, which have led the investors to sell the stock. Let’s evaluate them.

The Justice department is opposing the AT&T and Time Warner deal

AT&T operates in a capital-intensive sector where growth has already peaked. Therefore, in order to grow, the companies resort to mergers and acquisitions. In 2015, AT&T completed the purchase of DirecTV – the largest pay TV provider – for about $49 billion. Just a year later, the company agreed to buy Time Warner (NYSE: TWX) for about $85 billion.

The huge content of Time Warner – owner of CNN, HBO and Warner Bros. – and the reach of AT&T has great synergy. The deal was initially expected to close by the end of this year but the Justice Department is opposing the deal. Therefore, AT&T’s chief financial officer, John Stephens said during a recent investor conference that “the timing of the closing of the deal is now uncertain.”

Nevertheless, the executives of the two companies are unlikely to give up without a fight, as they believe that the Justice Department doesn’t have the legal grounds to deny this deal. The final outcome is likely to be decided in the court of law.

Huge debt even if Time Warner deal is approved

Unless AT&T invests to upgrade its business, or acquire companies, which have a good synergy, it will not be able to compete and stay ahead of its competitors. Hence, the investors don’t expect the company to remain debt free. However, the debt should not be unserviceable, endangering future dividend payouts.

The current debt to EBITDA of AT&T is 2.19 times. On completion of the Time Warner acquisition, the debt/EBITDA is likely to increase to 2.8 to 3 times. The management wants to bring down the debt level, as soon as possible. This casts a doubt over the continued dividend raises. Will the company sacrifice the dividend for debt repayment?

Unlikely.

AT&T has been cash flow positive for more than a decade. Companies pay out dividends from their free cash flows. The payout ratio has mostly ranged between 52 to 70% with the odd spike to 94% in 2014.

This year, the company generated a free cash flow of $12.8 billion in the first three quarters and paid out a dividend of $9 billion, resulting in a payout ratio of 70.5%. The management has maintained its guidance for 2017 and is likely to end the year with a free cash flow of $18 billion.

On the other hand, Time Warner has generated a free cash flow of $3.57 billion in the first three quarters of this year. In 2016, the company had earned a free cash flow of $4.25 billion. Let’s consider a conservative estimate and expect the company to earn only as much as last year.

If the deal receives the green signal before the end of the year – though highly unlikely – the combined entity will end the year with a free cash flow of $22.25 billion.

After the merger, due to the equity dilution, AT&T’s dividend liability will increase to $14.5 billion.

For the nine months ended September 30, the company paid an interest of $4.3 billion. So, for the whole year, the company may end up with about $6 billion in interest expense. Add the additional $1.3 billion, which AT&T has to bear on assuming new debt following the Time Warner deal and the total comes to $7.3 billion.

Adding the interest expense and the dividend payout, we get a figure of about $21.8 billion. This doesn’t leave the company with enough money to allocate for debt reduction.

However, the figure also doesn’t put the dividend in danger, as it can easily be accomodated in the free cash flow. But, is there a danger that AT&T’s free cash flows will decline in the short-term or the medium-term?

Financial performance of AT&T

2012 2013 2014 2015 2016
Revenue in billions 127.43 128.75 132.45 146.8 163.79
EBITDA in billions 31.14 48.87 32.14 46.65 51.72
EPS diluted 1.25 3.39 1.19 2.37 2.1

 

From the above figures, we find that AT&T has been able to gradually increase its revenues for the past five years. Similarly, the EBITDA has been on a gradual uptrend, which shows that the company has been able to maintain its profitability.

How has the company performed this year?

The company has so far maintained a flat performance in 2017.

In the third quarter of this year, the company’s revenues fell from $40.9 billion in 2016 to $39.7 billion. Similarly, the reported earnings per share (EPS) also fell from $0.54 to $0.49, which shows a marginal slowdown.

While the result is not something to write home about, it is not an outright disaster as well.

Analyst forecasts

According to Nasdaq.com, the analysts forecast a long-term growth rate of 4.8%. The consensus 12-month price target is $40, which is a good 17% above the current price of the stock.

With the likelihood of the small dividend raise intact and a possibility of price appreciation, let’s see what does the chart point to.

What does the chart forecast?

The stock had been forming a large ascending triangle pattern. However, three weeks back, the stock broke below the strong trendline support, which is a bearish sign. Nevertheless, the stock has a strong support at the $32, which has not been broken on a weekly closing basis since mid-2012.

On the upside, the trendline, which had been acting as a strong support until now is likely to act as a stiff resistance. However, In the long-term, if the stock climbs above the trendline at $36, a move to $40 and thereafter to $43 is possible.

Risks

If interest rates rise quickly, AT&T’s interest expenses will rise. Additionally, if the company is unable to stay ahead of the competition, its free cash flows will decline and the dividend payouts will be in danger.

However, this is unlikely to happen within a single quarter. We shall continue to track the stock and its financials.

Portfolio

In order to track our investments better, we shall maintain active portfolios for dividend and growth. This will help us compare our performance with the markets.

In that step, we shall include AT&T as the first stock in the dividend portfolio at the current levels of $34.22.

Featured image courtesy of Shutterstock. 

 

 

 

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2 Comments

2 Comments

  1. jeffc89

    November 15, 2017 at 8:27 am

    Good article Rakesh, I will look to invest in AT&T. Thanks!

    • Rakesh Upadhyay

      November 15, 2017 at 10:20 am

      Hello jeffc89,

      Thank you. We shall keep track of the company, as we have included it in our portfolio.

      With warm regards
      Rakesh Upadhyay

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Fundamental Analysis

A Contrarian Call on General Electric

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The General Electric (NYSE: GE) stock has been a huge under performer in 2017. It has fallen more than 43%, year to date while the S&P 500 is up about 15%. That says the kind of negativity surrounding the stock.

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Important points

  1. GE stock is being clobbered after it slashed its dividend by 50%
  2. The company will sell $20 billion of assets
  3. CEO John Flannery has laid out plans to turnaround the company
  4. We like GE as a contrarian bet

On Monday, during an investor day presentation, the new CEO of the company John Flannery outlined plans to turnaround the company. The stock reacted by falling more than 7% on the same day. If that was not enough, it was followed by another 5.89% drop on Tuesday.

The investors are bailing out of their positions in a hurry, plunging the stock below $18 levels. We, however, would like to go contrarian here and add GE to our portfolio. We believe that at the current prices, the downside risk is minimum while the upside potential is huge, if the management can walk the talk.

What are the reasons for our optimism, especially when others are in a hurry to sell their holdings.

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GE is the original Dow stock

The company was originally established by the great Thomas Alva Edison in 1890. A company that has survived for the past 127 odd years certainly deserves credit for its resilience. From the first light bulb to the age of super computers, the company has seen it all.

It has been able to reinvent itself and survive all the technological changes. It is the only original surviving Dow stock that was first included in the index in 1896.

However, we have seen many erstwhile companies flounder and go bankrupt. Is there a chance that GE will also follow suit? Let’s look at GE’s results and analyze how bad is the situation.

GE’s financial performance

The company’s performance has been sluggish in the past five years, which shows that the management did not take the necessary steps to overcome the plaguing issues.

  2012 2013 2014 2015 2016 YTD 5-Yr Growth
Revenue in billions 146.68 113.25 117.18 117.39 123.69 90.69 -3.33
Operating Margin % 20.31 13.65 14.19 14.36 14.42 11.9 -9.38
Diluted Earnings Per Share 1.29 1.27 1.5 -0.62 0.89 0.41 -0.06

Source: Morningstar

The above figures show that if the management doesn’t take the corrective steps soon, the company is unlikely to emerge from its downward spiral.

However, though the results are poor, GE is unlikely to go out of business anytime soon. It still has leadership position in its niche sectors. It only has to reorganize itself to emerge stronger.

What are some of the steps announced by the new CEO

We like a company’s CEO who accepts that there is a problem, which needs to be addressed. If the CEO backs his words with some unpopular measures for the long-term betterment of the company, we start to believe in the turnaround story.

Flannery did just that. He slashed GE’s dividend by 50%, from 24 cents quarterly to 12 cents, a move that is likely to hurt a lot of investors who had bought the stock for its dividend yield. This explains the plunge of the past two days.

However, the dividend cut will save the company $4 billion annually, which can be put to use for the turnaround.

Recent history shows that a dividend cut has been positive in the long-term

The S&P Global points to four companies – Pfizer, Abbott Labs, Kinder Morgan and Conoco Phillips – that have seen the largest dividend cuts since the financial crisis. A year after cutting their dividends, Pfizer rose 28%, Abbott 44% and Conoco Phillips 49%. The only laggard was Kinder Morgan, which was lower by about 4%.

Though this is not a very dependable reason to buy GE, it certainly shows that the companies that have used the money saved from dividend cuts smartly have rewarded the long-term investors.

What else does Flannery plan to do other than cutting its dividend?

Many analysts have said that GE had become unmanageable. On that front, Flannery has said that GE will be “more focused” and will shed assets worth about $20 billion. This is in contrast to the earlier two CEO’s Jeff Immelt and Jack Welch, but this is what the company needs at the moment. Power, aviation and health care are going to be the main area of focus.

GE will induct three new members into the board of directors, but will reduce the board’s size from 18 to 12. The board has also given a seat to Ed Garden, co-founder with Nelson Peltz of the $13 billion Trian Partners hedge fund. Peltz has taken more than a billion-dollar hit on his GE stake of about 70.9 million shares, disclosed in October 2015.

The lower guidance for 2018 is a welcome reset

Few analysts are negative following GE’s dismal guidance for the next year. The company cut its 2018 EPS guidance to $1.00-$1.07, well below the consensus street expectation of $1.28. However, we view this as a positive.

By doing this, Flannery has given himself enough room to maneuver without having to worry about disappointing the street. Also, he would want to start his innings at GE on a positive note, therefore, he is likely to give a guidance that he can easily beat. Hence, unlike others, we are not downbeat after seeing the lower guidance.

Shouldn’t we buy after the turnaround happens?

GE is looking to undo its previous mistakes and work towards a turnaround. Though turning a $155 billion behemoth is unlikely to happen quickly, we believe that positive indications can be seen within a year. As the stock markets are forward-looking, the stock price will start to recover well before the results turn positive.

What does the chart forecast?

GE has been in a long-term downtrend. With the plunge of the past two days, price has reached the downtrend line, which is likely to act as a support. Additionally, the 61.8% Fibonacci retracement level of the rise from the lows of 2009 to the highs in 2016 is at $17.17. As these two supports are close by, we expect the stock to find some support at the $17 levels. The RSI has also fallen into the oversold zone. Previous oversold readings on the RSI have led to a recovery in price. However, if the support breaks, the stock is likely to slide to its next major support of $14.

As the stock is currently in a downward momentum, we recommend buying GE in batches, instead of buying it all at once. The first lot of about 2% of the portfolio can be bought at the current levels. We, eventually, want to increase the stake to about 5% of our portfolio. Sharp intraday dips can be used to accumulate positions on the long side in the next few days or weeks.

For ease of calculation, we shall consider the purchase price as $18. This is the second stock in our portfolio, after the purchase of AT&T a couple of days back.

Risks

GE’s turnaround will suffer if the world economy slows down. The Chinese slowdown, the middle east unrest, the Brexit issues and other geopolitical issues can put brakes on the already anemic global recovery.

Flannery has a tough job at hand. Any misstep in the execution of the turnaround plan can sink the stock further.

Featured image courtesy of Shutterstock. 

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Analysis

Bet on Reversals and Limit Your Risks

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The S&P 500 Index (SPX) remains under the 2,600 mark and locked in a tight 13-point range. The S&P 500 Index (SPX) remains under the 2,600 mark and locked in a tight 13-point range. Indicators show that the index is still extremely overbought, and momentum is weakening. It briefly touched immediate support at 2,566 before closing at 2,578.9. The SPX must sharply pull back to have a shot at a sustainable breach of 2,600.

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With this view, we continue to focus on stock picks with limited risks but a lot of profit potential. Here are a couple of names that have recently reversed trends.

BK – Bank of New York Mellon Corp

BK has been on a downtrend for almost two decades after hitting its all-time high of 60.99. Technical analysis reveals a massive reversal structure after the stock breached resistance at 49. It is currently building a base at that level to sustain its momentum. The stock rallied after posting a higher low of 50.57. This indicates that BK is primed to make the next move up.

Accumulate shares to as close a price of 49 as possible. Buy more once it breaches resistance at 53. When it does, it is likely to hit 57 next. Take that out, and we get to 59. Last known resistance is its record high of 60.99. Break that, and we have a clear path to our target of 80.

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Should the stock break it’s support of 49, next line of support is 46 and then followed by 43. Strong support can be found at 36.

Weekly BK Chart

Monthly BK Chart

Summary of Strategy

Buy: 49 – 53

Support: 49, 46, 43 with strong support at 36

Resistance: 53, 57, 59, and 60.99

Target: New all-time high at 80

Useless: Only when support at 36 is broken

AZO – Autozone Inc

AZO is another stock that went on a downtrend after hitting its all-time high at 819.54. It posted a large bearish structure that led to a nosedive of more than $300 in value in a span of 25 months. Bulls defended support at 497 where the stock consolidated.

Yesterday, the stock rallied to a high of 633.24 before retreating and closed at 607.63. The action generated a candlestick indicating that AZO is not yet primed to make the next leg up.

This is good news as this provides you the opportunity to buy the stock at a discount. AZO may revisit its support at 583 which is a good level to accumulate shares. Buy more once the stock breaches resistance at 608 with a volume of at least 1 million. Breakout at 608 gives us a target of 720.

Weekly AZO Chart

Monthly AZO Chart

Summary of Strategy

Buy: as close to 583 with the intention of buying more when breakout at 608 is confirmed

Support: 583, 570, and 520

Resistance: 620, 671, and 702

Target: 720

Useless: Only when support at 493 is breached

Disclaimer: The writer has no investment stake in the stocks mentioned above.

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Recommendations

There’s a Lot of Upside With Stocks Reversing Trends

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The SPX continues to hover below the 2,600 mark with tightening range.Indicators show that the index is still in extreme overbought territory. It must pull back in order to sustain its ascent. Therefore, we continue to focus on stocks with limited risks but offer significant profit potentials.

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Here are a couple of names that are either making a reversal or ending a correction phase.

AIV – Apartment Invt & Mgmt Co

The stock has been on a downtrend since 2007 when it hit its all time high of 65.79. 10 years later, AIV has reverse its trend after it quietly broke out of its 35 resistance. Currently, the name is creating a base at 45 which is a very encouraging sign. It needs to turn 45 into a strong support level to have a chance at breaching major resistance at 50.

More often than not, stocks reversing from a multi-year downtrend have huge profit potential. They are at the point where risk-reward ratio is most favorable. AIV, for example, has come out of a 10-year downtrend, and it appears that the general public has yet to purchase the stock. Now is an opportune time to get in.

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Institutional investors are probably quietly building volume at 45 which means you have time to purchase the stock. Once the name goes above 50, it will attract momentum traders as well as the public to push the stock to 62 first. Break that, and we get the all time high of 95.

Weekly AIV Chart

Monthly AIV Chart

Summary of Strategy

Buy: Build volume now and buy more once it breaches 50

Support: 45, 42, 40, and 35

Resistance: 46.5, 50, and 62 last

Targets: 65 and 95

Useless: Only when support at 35 is broken

AXP – American Express Co

The stock has been correcting since 2014 after making the all time high of 96.24. We saw it retreat to 53 and established a base at that level. AXP has been rallying since and has now broken the major resistance at 93. In the last few weeks, however, the name has retreated from 96 and is currently forming a base at 93. This is an encouraging development as the stock needs to establish strong support to have a chance at breaking its all time high of 96.24.

Build volume at 93 with the intention of buying more once the stock breaks its record high. There is no known resistance after AXP moves above 96. The name has a clear path to the target of 135.

Weekly AXP Chart

Monthly AXP Chart

 

Summary of Strategy

Buy: Build volume now and buy more once it breaches 96

Support: 93, 90, 87, and 77

Resistance: 96.24

Target: 135

Useless: Only when support at 77 is broken

 

Featured image courtesy of Shutterstock.

Important: Never invest money you can't afford to lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here.



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