AT&T: Our Top Investment Until January 2022 (NYSE:T)

AT&T (NYSE: T) has traditionally been a company that we’re a large fan of. The company, however, has fallen out of popularity due to COVID-19 and a shift in investment sentiment to favor high-flying technology stocks. As the company’s share price teeters back down to $28, within $2 of its mid-March lows, we want to take the opportunity to recommend our best investment opportunity until January 2022.

(Source: AT&T)

Transformation

This year is expected to be a transformative one for the company. It is focused on executing across its diverse asset portfolio.

(AT&T Priorities – AT&T Investor Presentation)

AT&T is focused on several major aspects of its business. The largest is nationwide 5G coverage and FirstNet. Nationwide 5G is essential to the company maintaining competitive advantage versus T-Mobile (NASDAQ: TMUS) and Verizon (NYSE: VZ). It also provides additional sources for new customers through self-driving cars and home internet.

Additionally, the company is focused on FirstNet. FirstNet is a unique cellular network for first responders that provides AT&T with unique spectrum. It provides the company with the reputation of providing first responders with unparalleled quality and has achieved rave reviews. And it gives the company excess bandwidth to increase speeds for current customers.

Past this, 2020 is an enormous year for HBO Max, the company’s new streaming service based on Time Warner. The company is improving fiber-based connectivity, software-based entertainment, and increased customer engagement. All of this shows AT&T’s continued focus execution on its plans.

The company is effective and efficient in everything that it does. It’s focused on maintaining a strong balance sheet and allocating its capital. We’ll focus on AT&T’s capital allocation in other sections of the article, however, it’s clear that the company continues to execute across all lines of its business while maintaining incredibly strong financial positioning.

Continued Financial Performance

Despite the difficulties of COVID-19, AT&T remains committed to continued financial performance.

(AT&T 2Q 2020 Financial Performance – AT&T Investor Presentation)

The company saw its EPS decline by $0.06 YoY, representing a high-single digit decline from $0.89 in 2Q 2019 to $0.83 in 2Q 2020. That decline represents the worst quarter from COVID-19. On the back of this came a $4 billion decline in revenues YoY, or a near-10% decline. The majority of these impacts were COVID-19-related, along with other FX-related issues.

More importantly, AT&T cut its capital expenditures, however, it’s continued to invest in its business. Cash flow from operations have remained incredibly strong. The company’s 2Q 2020 FCF was $7.6 billion with a 2Q 2020 dividend payout ratio of 49%, although it’s a typically strong quarter. On average, the company targets a mid-60% payout ratio.

That payout ratio is substantial with a more than 7% dividend yield. It’s comfortably affordable for a company with manageable near-term debt towers that have refinanced its debt at long-term low rates. The company is continuing to reward shareholders, something that we expect it to continue for the long run. As we’ll see, that’s the basis for our investment recommendation.

Financial Profile

AT&T’s financial profile highlights how the company, on top of its most recent-quarter results, can continue to perform.

(AT&T Financial Profile – AT&T Investor Presentation)

It has continued strong FCF and has improved its dividend payout ratio from the range anticipated at the start of the year. AT&T originally targeted a dividend payout ratio in the 60’s%, but has since shifted that to the low 60’s%. The company is continuing to maintain strong gross capital investment, and its FirstNet build remains ahead of track.

AT&T took advantage of the COVID-19-induced decline in interest rates to significantly improve its upcoming debt maturities. However, it’s worth noting that even before that, the company had sufficient additional FCF to pay off its remaining debt towers each year for the next 5 years. AT&T would be better served buying back shares, but its debt maturities are manageable.

The company is also continuing asset sales and other strategies to improve its portfolio. It is exiting a period of massive capital spending, which could allow expenses to go down soon.

AT&T January 2022 Investment Recommendation

For investors who want to get involved in AT&T, we have a unique options-based recommendation strategy, taking advantage of the recent drop in the company’s share price.

(AT&T Option Chain – TD Ameritrade)

The above image shows AT&T’s option chain with a Jan. 2022 expiration date (just under 16 months from now). At this time, the stock price is $28.3/share. Investors can choose to sell a cash-secured Put with a $28 strike and a Jan. 21 expiration at a midpoint price of $3.65/share. That means you “put up” a net $2435.

There are two scenarios here. The first is that the company’s stock is at $28 or more by January 2022. Under that scenario, you simply keep your $365 in exchange for $2435 that was unavailable to you for 16 months. That represents annualized returns of 11.2%, a great cash yield for any market environment.

The alternative is the share price is below $28. In that scenario, you get AT&T shares at a net cost basis of $24.35/share. That means a yield on cost of more than 8.5% from a quality long-term dividend player with a mid-60s payout ratio. That’s in addition to a policy of paying down debt that’ll soon be completed and turn into shareholder rewards.

Either way, you stand to generate substantial shareholder rewards.

AT&T Risk

AT&T’s risk is obviously the risk of a global economic downturn. While watching TV and using your cell phone are integral into people’s lifestyles, those without jobs eventually cut expenses. Arguably, in this sense, COVID-19 has been much worse to AT&T than a recession, with the closing of movie theaters and the pressure on small businesses.

However, given that AT&T continued to perform and maintain revenue during 2008, and that the worst of COVID-19 (widely expected to be 2Q 2020) is over, along with the company’s low-60s % payout ratio during 2020, it clearly has the ability to survive a downturn. More so, the collapse in the share price due to COVID-19 actually reveals a much bigger opportunity than the COVID-19-related drop in revenue and income.

Conclusion

AT&T is an impressive company with the ability to generate long-term shareholder returns. In many ways, 2020 has been a year of transformation for AT&T, although that has been heavily overshadowed by COVID-19 and its impact on the company’s financials. Despite this, we see it as having the ability to continue long-term outperformance.

We recommend investors take this time as an opportunity to invest in AT&T utilizing a unique options-based strategy. That strategy results in shareholders receiving AT&T at a much lower price from its current price or, alternatively, generating a high cash yield. At this time, this is our top idea for investors until January 2022.

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Disclosure: I am/we are long T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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