Forget AT&T: Here Are 2 Better Dividend Stocks

8/26/20

By Lee Samaha, MotleyFool

The 7% dividend yield at telecom and media giant AT&T (NYSE:T) is eye-catching enough to attract many investors. However, it may well turn out to be structurally challenged -- its communications business is seemingly in decline, and streaming rivals are challenging its pay-TV business. That means its dividend may not prove sustainable over the long term.

On the other hand, industrial companies such as MSC Industrial (NYSE:MSM) and Caterpillar (NYSE:CAT) carry good dividend yields, and their cyclical challenges could be resolved in a year or two, leaving businesses and dividends back in growth mode -- something that might not be the case for AT&T given is structural challenges. Let's take a look at both.

MSC Industrial

It's not going to be a pretty fiscal 2020 for the industrial supply company, and its next fiscal year won't be much better.

A car production plant.

THE SLUMP IN AUTOMOTIVE PRODUCTION HAS HURT MSC INDUSTRIAL, BUT IT WILL GET BETTER IN 2021. IMAGE SOURCE: GETTY IMAGES.

The company's average daily sales have fallen off a cliff in 2020, with the latest July sales data showing a 12.6% year-over-year decline. Meanwhile, management continues to refer to extremely weak automotive, aerospace, and heavy-industries spending. For reference, MSC's sales are its customers' operating expenses, and as manufacturing activity slows, so does MSC's sales growth.

MSC Industrial average daily sales.

DATA SOURCE: MSC INDUSTRIAL SUPPLY PRESENTATIONS.

What did you expect?

Some context is necessary. COVID-19 has led to sudden shutdowns in automotive production and aerospace activity, along with a slump in the price of oil and other leading indicators of heavy-industries spending. In fact, it's hard to imagine a worse set of circumstances for a supply company.

However, on the basis that the spring of 2020 will mark a trough in industrial activity, it looks likely that MSC will start to grow sales again sometime in calendar 2021. If this assumption turns out to be correct, then MSC Industrial is looking like a good option for income-seeking investors.

The company's 4.5% dividend yield looks well supported by estimated earnings -- $4.58 and $4.48 in 2020 and 2021, respectively -- and by cash flow over the next couple of years. Moreover, the company should end up in growth mode at the end of next summer while trading at less than 15 times earnings.

It's not going to be an easy ride by any stretch of the imagination, but if 14 times earnings and a 4.5% dividend yield is the worst that can happen, then MSC Industrial is worth buying for dividend investors.

Caterpillar

The construction, mining, energy, and transportation equipment manufacturer certainly faces more than its fair share of near-term headwinds right now. The company's latest retail sales data shows ongoing declines, implying Caterpillar's sales to its retailers will come under extended pressure.

During the second-quarter earnings call, CEO Jim Umpleby disclosed: "The decrease in dealer inventories in this past quarter was greater than we expected. We now anticipate our dealers will reduce their inventory by more than $2 billion by year-end."

Wall Street analysts, therefore, have Caterpillar reporting a 23% decline in sales to $41.6 billion. Moreover, given that Catepillar's profit margin tends to be driven by movements in volume, analysts have Caterpillar's earnings before interest, taxes, depreciation, and amortization (EBITDA) declining from $9.6 billion in 2019 to $6 billion in 2020.

Caterpillar retail sales.

DATA SOURCE: CATERPILLAR PRESENTATIONS.

It's definitely a grim near-term outlook for Caterpillar. On the other hand, some key end markets appear to be growing again for the company. For example, surging U.S. housing starts should lead to demand for smaller construction equipment, and if infrastructure is built around new homes, larger construction equipment demand should pick up.

Meanwhile, metals and mining prices are starting to approach pre-COVID levels, so capital spending by mining companies could improve -- and oil prices are stabilizing.

US Housing Starts Chart

DATA SOURCE: YCHARTS

If analysts are right, the $5.19 in earnings per share in 2020 will easily pay for a $4.12 dividend per share and earnings and cash flow should bounce strongly in 2021 as sales recover. All told, Caterpillar's 3% dividend yield looks safe for investors.

Cyclical, not structural

All told, the problems at Caterpillar and MSC Industrial appear to be due to cyclical issues in the economy, while AT&T's problems look more like structural issues relating to ongoing weakness in wireless revenues and pay TV. So investors might find that they end up earning a lot more in dividends from the two industrial companies than they will from AT&T over the next decade. 

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