This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
In the world of dividend growth stocks, there are some legendary dividend stalwarts such as Coca-Cola (KO), Johnson & Johnson (JNJ), and many others. However, a strong dividend record is not just limited to the household names. There are dozens of companies that have multi-decade dividend increase streaks that are not as well known.
A good example of this is Telephone & Data Systems (TDS). The company has increased its dividend for over 40 years in a row. As a result, it qualifies as a Dividend Champion, a group of stocks with at least 25 consecutive years of dividend increases.
Telephone & Data Systems offers an attractive combination of a 3.5% dividend yield, steady growth, and a low valuation which could lead to high total returns in the years ahead.
Business Overview
Telephone & Data Systems is a telecommunications company that provides customers with cellular and landline services, wireless products, cable, broadband, and voice services across 24 U.S. states. The company’s Cellular Division accounts for more than 75% of total operating revenue. TDS started in 1969 as a collection of 10 rural telephone companies. Today the company has a market cap of $2.2 billion and more than $5 billion in annual revenue.
On November 5, 2020 TDS reported Q3 2020 results for the period ending September 30, 2020. The company grew its total operating revenues marginally to $1.324 billion. Diluted earnings were $78 million or $0.66 per share compared to $18 million or $0.15 per share in Q3 2019.
TDS Telecom continues to deploy fiber and is now covering 280,000 or 34% of its wireline service addresses. Management has narrowed its 2020 outlook and is now expecting service revenues of around $3.05 billion. Total expected operating revenues for TDS Telecom are approximately $975 million. Total estimated revenue for 2020 is now $4.03 billion. We are expecting $1.95 in earnings for 2020, to go along with ~$42 in book value per share.
Growth Prospects
TDS has exhibited a markedly volatile performance record, with earnings oscillating significantly. During the 2010 through 2019 stretch, the company’s earnings-per-share have actually declined by an average compound growth rate of -2.1% per year. This result came about as minor growth in the top line was more than offset by a declining profit margin and a slightly higher share count.
While earnings have been volatile, book value per share has grown by 2.0% per year over the last decade. The book value trend is much more consistent. For this reason, we prefer to use book value instead of earnings-per-share for measuring the company’s financial strength. As TDS generally distributes over half of its earnings as dividends, we are projecting book value per share to grow by a 1.5% average annual rate over the next five years. Using ~$42 in expected book value for 2020, this implies the potential for just over ~$45 in book value during the next half decade.
It’s important to note that TDS has an 82% stake in U.S. Cellular and essentially relies on this stake to achieve growth, as its other businesses, namely residential wireline, broadband and voice connections, have failed to grow in recent years.
Competitive Advantages
TDS has put together a notable dividend growth record, raising its dividend for four and a half decades. This is a testament to both the company’s ability to pay an increasing dividend and management’s commitment to this payout.
With that said, TDS has exhibited serious volatility in its results. This is a negative that investors should take into consideration. As TDS operates in a highly competitive business, with very large and able competitors, it lacks a meaningful competitive advantage.
Another risk factor of TDS is its strong dependence on U.S. Cellular, which operates in an extremely competitive market. As U.S. Cellular generates the vast majority of the revenues and earnings of TDS and is currently its most important growth driver, any headwind that may show up will have a severe impact on results. TDS Telecom is lucky in that its services are heavily in-demand throughout the COVID-19 pandemic which has led us into the latest recession.
The company’s previous recession performance was cyclical, posting earnings-per-share of $2.63, $0.74, $1.63 and $1.25 during the 2007 through 2010 stretch.
Potential Returns
Despite the volatile historical earnings of TDS, the company has a positive growth outlook. In the meantime, shares are attractively valued. As noted above, a 1.5% annual growth in book value per share would lead to ~$45 in book in the next five years. Keep in mind that this is merely one possibility out of many and is used as a starting baseline.
During the last decade shares of TDS have traded hands with an average price-to-book value (P/B) of 0.74. For a fair value estimate we are using 0.70 times book value. When combined with the ~$45 in expected book value, this implies the potential for a future share price of ~$31.70 in five years (keeping in mind that you are going to get a very precise number, but there are a very wide range of possibilities).
Next, TDS currently pays a quarterly dividend of $0.17 per quarter or $0.68 on an annual basis. If this payment were to grow by 3% annually – slightly higher than expected book value growth, but lower than the historical dividend growth rate record – this would result in a dividend near $0.79 after five years. Collectively you would anticipate receiving ~$3.70 or so in cash payments during the next half decade.
In total, investing in TDS could generate a total potential value of ~$35.40 per share. As shares are presently trading for ~$19.50, this implies the potential for 12.7% annualized gains over the next five years. We find this to be an attractive rate of return for TDS stock.
Final Thoughts
Telephone & Data Systems is a lesser-known dividend growth company with a dividend increase streak nearing 50 years. We expect this streak to continue, although it is important to note that earnings results have been volatile in the past and could very well continue to be volatile moving forward.
Still, total return potential is compelling, with the security offering a historically low price-to-book ratio and a 3.5% starting dividend yield. Even without much growth expected, TDS is a Dividend Champion worth a look.
