Time to Call on This Budding Dividend Growth Stock

Telecommunications giant AT&T (NYSE: T) has, for many years, been known as a stalwart for dividends. This reputation is well-deserved, as AT&T is one of the highest yields in the S&P 500 index.
As of its Nov. 4 closing price, the stock offers a juicy 5.6% dividend yield, which is much higher than the average stock yield these days. The S&P 500 index only yields about 2% on average.
AT&T is a great pick for high yield, but it has not been as good of a stock selection for dividend growth. Since the company already distributes most of its annual free cash flow, there wasn’t much room for strong dividend growth in the past several years.
To that end, AT&T only raised its quarterly dividend by a penny per share each year since 2008.
But that may be about to change. Thanks in large part to its forthcoming acquisition of DirecTV (NASDAQ: DTV), AT&T expects significant growth in free cash flow next year. That could pave the way for higher dividend growth going forward.

Free Cash Flow Growth in 2015 and Beyond

AT&T has always been a high-yield stock, but it has disappointed investors for its lack of dividend growth. The reason it has not been able to increase its dividend by much over the past several years is because it simply didn’t have the cash to afford higher raises.
For example, in 2014 AT&T distributed $9.5 billion in dividends to investors. The company generated $10.1 billion in free cash flow last year, meaning that it carried a 94% payout ratio as a percentage of free cash flow. That left very little room for stronger dividend growth.
This year, AT&T’s payout ratio has trended down, as the company has done a great job of growing free cash flow. AT&T generated $13.3 billion of free cash flow just in the first nine months of the year. This represented 52% free cash flow growth, year-over-year. As a result, it maintained a 54% dividend payout ratio as a percentage of free cash flow in this period.
The reason for this is because AT&T has significantly reduced capital expenditures. Capital spending was $13.3 billion over the first nine months, down from $16.8 billion in the same period last year. AT&T made significant investments in upgrading its network and services, and with those investments completed, the company is able to reduce spending.
Going forward, AT&T expects even more growth in free cash flow. Through its acquisition of DirecTV, AT&T will be able to realize significant cost synergies in incorporating its takeover target. This will allow it to eliminate duplicative expenses, while gaining millions of new customers. Last quarter, AT&T realized 19% growth in consolidated revenue.
For the full year, AT&T expects consolidated revenue to increase by double digits on a percentage basis. In conjunction with cost synergies, this growth should flow directly through to free cash flow. AT&T management expects $15 billion or better of free cash flow in 2015.
Longer term, the company expects a much lower dividend payout ratio than it has carried in previous years. AT&T’s updated financial guidance for 2016-2018 calls for free cash flow to continue growing each year from 2015, resulting in a very comfortable free cash flow dividend payout ratio in the 70% range.

High Yield, Plus Potential for High Dividend Growth

Assuming AT&T meets its forecasts, the company will realize very strong growth in free cash flow. This will help meaningfully reduce its dividend payout ratio next year and beyond. Management’s aggressive acquisition of DirecTV was clearly a smart strategy, and investors may realize the benefits through stronger dividend increases moving forward.
For this reason, investors may want to start thinking about AT&T as not just a stodgy high-yield dividend stock, but as a dividend growth stock as well.
For more stocks that consistently up their payouts while ringing in profits, click here.