A Cheap Telecom With a Burly Yield

Michael Hodel: AT&T is one of our favorite telecom stocks right now. The shares have been beaten up on investor concerns over the company's debt load and over some of the strategic choices that AT&T has made over the last few years. And we share some of those concerns. We think that AT&T has made some questionable capital allocation decisions recently, including its acquisition of DirectTV. But we think at this point, the stock has been unfairly beaten up to the point where it's now attractively priced. The shares also offer an attractive dividend yield, about 6.5%. And while we don't think that dividend yield is as rock-solid as maybe it was a decade ago, we still think it's reasonable to assume that AT&T continues to pay out a dividend and grows that dividend at a pretty consistent rate over the coming years. And we think investors will grow increasingly comfortable with that dividend as the firm uses its cash flow to repay debt and bring its leverage metrics back down into a more historical range. And we do think that the firm's wireless business remains competitively advantaged and that it will continue to generate great cash flow over the next several years. And we also think the Time Warner assets, while expensive, are also very well positioned competitively and that AT&T should be able to generate solid cash flow out of the media business over time. So while we don't think there's a lot of synergies between the telecom business and the media business, we do think that each business is a solid performer in its own right. And some of the more questionable parts of AT&T, like its satellite television business, and its consumer Internet access business, that investors pay a lot of attention to, they've actually gotten fairly small at this point, as a percentage of the total company. So when you peel back the different elements of AT&T, we think that the good parts of the business are large enough to outweigh any of the trouble that the firm might have and some of the smaller segments that aren't doing so well. And you put it all together, we think that the firm will reduce leverage, the firm will produce enough cash flow to support the dividend, and that will lead to a reevaluation of the shares over time, as investors grow more comfortable with where AT&T is positioned and how the firm is likely to deploy cash over the next several years. We do think that because of all of the decisions that AT&T management has made over the last five years or so, that there's not a lot of room for the management team to make any major capital allocation decisions from here, which we think reduces the risk of future poor capital allocation decisions going forward. That focus on reducing leverage is really going to keep the management team disciplined. At least for the foreseeable future.