Dividend Opportunities in Telecom

Michael Hodel: For most of 2019, we've been recommending AT&T shares as the most attractive in the U.S. telecom industry, sporting a generous yield in addition to trading at a significant discount to our $37 fair value estimate. However, over the last several months, AT&T shares have rallied strongly, especially after Elliott Management started to take an interest in the company and push for changes in the management team and the corporate strategy.

With this stock now trading at a little bit of a premium to our fair value estimate, we don't see a ton in the U.S. telecom industry that's particularly attractive for dividend-seeking investors. Right now, if we were to pick one stock in the sector, we would look at Comcast. While Comcast shares don't yield as much as AT&T or even Verizon, they still yield about 2%. And importantly, the company doesn't pay out nearly as high a percentage of its free cash flow as AT&T or Verizon do. Comcast pays out about half as much as those two companies, roughly 25% to 30% of its free cash flow, and that gives the firm a lot more room to grow its dividend over time. So, while AT&T and Verizon have been growing their dividends about 2% annually, Comcast most recently raised its dividend 10%. And we think that dividend growth is set to continue over the next several years as Comcast digests the Sky acquisition, continues to repay debt, and continues to shift its focus more towards the dividend and away from share repurchases. And Comcast, we expect, will eventually return to share repurchases once it gets its leverage down to a more comfortable range. But we do think that that dividend will make up a more important portion of the firm's total capital return over time.

And with regard to the balance sheet, Comcast and AT&T have similar leverage. So, Comcast after the Sky acquisition has about 3 times debt to EBITDA, which is a little bit higher than where AT&T is at, at about 2.7 times, but AT&T also has its pension obligations that aren't factored into that metric. So, on an apples-to-apples basis, the balance sheets between Comcast and AT&T are roughly comparable. And so, we think Comcast has equal if not a little bit better credit profile than AT&T does.

So, Comcast isn't a compelling bargain today. It trades right in line with our $45 fair value estimate. But relative to AT&T and Verizon, which again are trading at premiums to our fair value estimates, we view Comcast as somewhat more attractive today.