How The ATT Time Warner Deal Looks To One Investor

Blue chip companies with a long history of growing dividends are the cornerstone of many portfolios. For investors wanting to increase their holdings of these companies these are challenging times. The universe of companies is well-known, notably in the late David Fish’s CCC lists, but in this sky-high market most are high - or at best fairly priced. Fortunately, it’s still possible to find investment opportunities by identifying dividend growth stocks that are offering record high yields relative to their own history. In this article we discuss three such companies and revisit two others previously identified.

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The Significance of Record Yields

The significance of record high yields was first discussed in Historically High Yields For The Dividend Investor and later here and here. High yields in dividend growth companies are almost always due to low share prices relative to the dividend. These stocks have several advantages:

  • More shares relative to the dividend history are purchased in the initial investment.
  • There is more dollar growth in dividends received because of owning more shares.
  • There is more potential for capital gains as the stock returns to prices more in line with its dividend history.

The discussions here focus on the conditions leading to current high yields and their future normalization. More general discussions of each company can be found in the many other articles about each on Seeking Alpha.

Black line = yield. Blue line = stock price. Charts from dividends.com

AT&T Inc. (T)

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AT&T currently yields 6.30% at a recent low price of $31.75. Since the end of the recession it’s yield range is 4.68% to 6.59%, with a brief spike to 7% during the great recession. The average yield over time is about 5%. A return to a 5% yield implies a share price of $40.00.

The steady rise in yield over the last two years corresponds with a period of great change at AT&T. In October 2016 they announced the pending acquisition of Time Warner for $108 billion, which came on the heels of the $67 billion DirectTV acquisition and numerous other significant actions. Investors were rightly concerned about the uncertainty generated by these changes. The stock price went from $43 to $30.35, and the yield rose from 4.68% to 6.59%. The fact is, however, AT&T did what was necessary to continue to compete in the rapidly advancing technology landscape, and for a company with $163 billion in annual revenue only a very large deal will make a difference. Whether AT&T made the right moves remains to be seen, but the company says that the merger will be accretive to earnings and cash flow in the first year.

Philip Morris (PM)

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Phillip Morris currently yields 5.85% at a recent price of $77.89. Over the last 10 years its yield has ranged from 3.51% to 5.89% with an average of around 4%. A return to the 4% average yield at the current dividend of $4.56 implies a stock price of $114, 42% higher than today. Alternatively, an investor can buy 42% more shares today than if the price reflected the average long-term yield.

Philip Morris sells tobacco products globally outside the U.S. and with a market cap of $123 billion is one of the world’s largest tobacco companies. The share price decline over the past two years reflects anti-tobacco public opinion in many parts of the world. In addition, the industry is grappling with major changes, including cannabis legalization, e-cigs, and PM’s own big bet on the tobacco heating device iQOS. Many people believe that the tobacco industry is in permanent decline and that PM shares will never return to previous heights. Perhaps, but tobacco has been under attack since the Surgeon General’s report in 1964, and tobacco companies have been among the best performers during that period. Altria (MO), from which PM was spun off, has been the best performing stock in the world.

Cardinal Health (CAH)

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I first recommended Cardinal Health as a high-yield value stock in October 2017 at a price of $62.01. It is an even better value today at a recent price of $51.63 and a yield of 3.69%. Over the last 10 years its yield has ranged from 0.82% to 3.88% with an average of around 2%. A return to the 2% average yield at the current dividend of $1.91 implies a stock price of $95, 43% higher than today. Alternatively, an investor can buy 54% more shares today than if the price reflected the long-term yield.

Cardinal Health is part of an oligopoly in the drug and medical product distribution business, along with McKesson (MCK) and AmerisourceBergen (ABC) Over the past two years all three have been beset by two main issues. The first is a general pressure on drug prices from Medicare, health plans, and the White House. The second is the clubbing all companies in the sector received when Amazon announced it was moving into pharma supply in May 2017. As to the first issue, Cardinal has proved through 22 years of increasing dividends that it can compete with fierce competition and challenges in the macro health care environment. As for the second issue, Amazon has not made a dent in the sector and the share prices of many companies, e.g., Walgreen Boots (WBA), Kroger (KR), Target (TGT), and CVS (CVS) have already recovered from this or similar Amazon announcements. See here and here for informative views of the issue by industry insiders.

Summing up

Opportunities for the value-seeking, income-oriented investor have become scarce over the last few years of this bull market. Reliable dividend growth stocks near record high yields are one place where opportunity is still there. Philip Morris, AT&T, and Cardinal Health are three such companies. Investing in shares now will capture yields rarely seen in their history, as well as above average potential for capital appreciation. As might be expected, there are reasons why these three are selling at depressed prices. If everything was fine, shares would be at high prices and yields would be unremarkable. The average investor looks at the current issues each company is facing and stops there. A more farseeing investor sees instead the long histories of increasing dividends and successful execution under all economic conditions, and has confidence that they will continue to adapt, survive, and thrive. Opportunity knocks!

Disclosure: I am/we are long CAH, PM, T, MO, TGT, KR, WBA.

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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