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Are Dividend Stocks Safe?

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Gordon Pape

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We were sitting around the clubhouse after golf, drinking tea (it used to be beer but everything changes as you get older). The topic of conversation was Europe. The election of a Socialist president in France and the collapse of the Greek coalition had once again roiled world stock markets and everyone was worried.

"I don't have a clue where to put my money," one of my friends said, to nods of agreement from the others.

"Dividend-paying stocks," suggested a retired executive. "They're safe."

At that point, everyone looked at me in anticipation. I took a sip of tea and thought about it a moment. "Not necessarily," I said finally. "There are dividend stocks and dividend stocks. Some are much more risky than others."

I went on to point out that during the crash of 2008-09, even dividend stocks that had been thought to be rock solid were battered. Canadian banks, none of which was ever in serious trouble, were classic examples. Royal Bank (RY) lost almost half its market value, dropping from over $51 a share in September 2008 to $27 in mid-February 2009. Bank of Montreal (BMO) fared even worse. In May 2007, it was trading at over $71; by February 2009 it was down to $24.66, a loss of about two-thirds of its value. It has never regained its 2007 high. And the banks were thought to be safe!

Dividend stocks in cyclical industries fared even worse. Suncor Energy (SU) plunged from over $70 a share in May 2008 to just over $20 in November, a loss of more than 70%. Teck Resources (TCK) almost dropped out of sight, falling from almost $52 a share in May 2008 to $3.80 in February 2009 - a staggering 93% loss. Yes, there are dividend stocks and dividend stocks.

Not surprisingly, my friends looked somewhat crestfallen after I unloaded all these numbers on them. "So what the heck are we supposed to do?" one of them finally asked.

There are two parts to that answer. The first is to focus on dividend-paying stocks in stable industries - those which are likely to weather any recession with minimal structural damage. The second is to look for industry leaders with a solid franchise, good cash flow, and a strong dividend history.

One sector that has strong defensive characteristics is utilities. We have pretty much exhausted the list of top-quality Canadian stocks in this area, such as Fortis (TSX: FTS, OTC: FRTSF), Enbridge (ENB), and Canadian Utilities (TSX: CU, OTC: CDUAF). But there are many good choices in the U.S. market.

I recommended one of them, Southern Company (SO) in February at US$44.30. In mid-April, Southern announced a 3.7% hike in its dividend to US$1.96 per share annually. It was the 11th year in a row that the company has increased its payout. Readers who bought at the original price will receive a yield of 4.4% over the next 12 months. Meanwhile, the share price has moved up to US$45.54. I still regard Southern as a Buy.

Another sector that is worth the attention of defensive-minded investors is telecommunications. Here again, we already have the most attractive Canadian companies on our Recommended List: BCE Inc. (TSX, NYSE: BCE), Rogers Communications (RCI), and Telus (TU). But we have no U.S. telecom stocks, a situation we'll remedy this week.

AT&T (T)

There are several major players in the U.S. telecom space. In terms of payout, Louisiana-based CenturyLink (CTL) is the most attractive with an annual dividend of $2.90 to yield 7.3% based on Friday's closing price of $39.52 (all figures in U.S. currency). Analysts are high on the stock but I see it as higher risk because the company is trying to stem a gradual decline in revenue as it loses landline customers.

A case could also be made for Verizon (VZ), which closed on Friday at $41.16. The shares pay $2 annually to yield 4.9% and the company has a very strong wireless franchise.

However, my nod goes to industry giant AT&T (T), which is far from being the fuddy-duddy company that many people imagine. This is the largest communications holding company in the world in terms of revenue, with customers in virtually every country on the planet. It is the leading U.S. provider of local and long distance voice services and has more than 100 million wireless customers in the United States alone. AT&T claims have the fastest broadband network in the U.S. and is a major player in the cable television, satellite TV, and Wi-Fi sectors.

The company traces its roots all the way back to the invention of the telephone by Alexander Graham Bell in 1876. Over more than a century it grew into a huge monopoly until 1984 when the company was broken up by the U.S. Justice Department. Local telephone services were spun off into "baby Bells") but AT&T retained its long distance, manufacturing, and research and development arms. These were held in a new company known as SBC Communications.

The U.S. Telecommunications Act of 1996 triggered more dramatic changes in the landscape. SBC established itself as a global communications provider by acquiring Pacific Telesis Group (1997), Southern New England Telecommunications (1998), and Ameritech Corp. (1999). In 2005, SBC bought AT&T Corp., creating the new AT&T. The transformation of the company was completed with the acquisition of BellSouth in 2006 and the consolidated ownership of Cingular Wireless and YP.com.

The new AT&T, which is based in Dallas, is one of America's largest companies. First-quarter revenues came in at a staggering $31.8 billion, up $575 million or 1.8% from the comparable period in 2011. Net income attributable to AT&T totaled $3.6 billion ($0.60 per share, fully diluted), up from $3.4 billion ($0.57 per share) in the year-earlier quarter. Free cash flow - cash from operating activities minus capital expenditures - totaled $3.5 billion.

The company is using some of that cash to aggressively buy back its stock in the open market. During the quarter, AT&T repurchased 67.7 million of its shares for $2.1 billion. It has authorization to buy back up to 300 million shares.

What is especially attractive about AT&T is the fact it is showing strong growth in key areas. The company posted a net increase in total wireless subscribers of 726,000 in the first quarter to reach 103.9 million in service. This included gains in every customer category. Total wireless revenues, which include equipment sales, were up 5.4% year-over-year to $16.1 billion. Wireless service revenues increased 4.3% to $14.6 billion while wireless data revenues, driven by Internet access, access to applications, messaging, and related services, increased by more than $1 billion, or 19.9%, from the year-earlier quarter to $6.1 billion.

Even wireline operating income, which has been falling in many telecom companies, gained 2.4% year-over-year to $1.8 billion as margins improved to 12.2% from 11.8%.

The shares currently pay a quarterly dividend of $0.44 ($1.76 a year) to yield 5.2% based on Friday's closing price of $33.59. AT&T has raised its dividend every year since the 1984 break-up so investors who buy at the current price can expect their yield to gradually improve over the years.

Note that the payout is not eligible for the dividend tax credit. Also, a 15% U.S. withholding tax will apply to dividends paid into Canadian non-registered accounts and TFSAs, but not to RRSPs and RRIFs. For non-registered accounts, a foreign tax credit can be claimed for the amount withheld.

AT&T is not immune to a market plunge, but no stock is. However, in terms of overall risk it is an excellent addition to a defensive portfolio, offering stability, a good yield, and modest growth potential.

Action now: AT&T is a Buy at US$33.59.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.3/5 (10 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 2 years ago
Great discussion thanks!

Would love to see you further discuss the 70s, 80s experience. I.e. what Buffett has highlighted, that commodity-like products and their businesses are prone to over supply situations; impact of rising interest rates or inflation on dividend paying corporations, etc.

The ability to raise prices is hugely beneficial. My provider, Telus, is planning a number of rate increases. I don't own any Telus.

Please leave your comment:


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