American Tower (AMT): A Quality REIT With 20% Annual Dividend Growth

American Tower (AMT) is unlike most real estate investment trusts (REITs).

 

The company’s business model has very low maintenance capital needs, throws off excellent free cash flow each year, provides recession-resistant services, and consistently enjoys renewal rates close to 100%.

 

While American Tower isn’t one of the 28 best high dividend stocks for current income and only began paying dividends less than six years ago, the company has nearly tripled its quarterly payment over this time and raised its payout each and every quarter.

 

With management targeting at least 20% annual dividend growth forward, let’s take a closer look at this unique REIT.

 

Business Overview

American Tower was founded in 1995 and converted to a REIT business structure in late 2011, minimizing its taxes on its real estate assets and kicking off its dividend program.

 

The company owns a portfolio of approximately 147,000 towers that it leases out to wireless carriers (most towers have capacity for at least four tenants).

 

American Tower’s infrastructure is used by carriers to provide wireless service to consumers and businesses, transmitting signals between towers and mobile devices.

 

American Tower operates similarly to a triple-net lease REIT in that its tenants pay for almost everything needed to transmit signals (e.g. communications equipment, cables, antennae) except the tower and land that American Tower maintains (i.e. the company’s maintenance costs are very low for a REIT).

 

 

Approximately 56% of American Tower’s property revenue and more than 70% of its total profit are generated in the U.S. with the rest from international markets (Asia 18% of revenue, Latin America 17%, EMEA 9%).

 

However, over 70% of the company’s communications sites are located internationally (prices and capacity utilization are lower in those regions today).

 

American Tower’s large international reach results in reasonable tenant diversification. The company’s largest customers are AT&T (16% of revenue), Verizon (15%), Sprint (10%), and T-Mobile (8%).

 

Business Analysis

American Tower has arguably one of the most predictable and lucrative business models of any dividend stock in the market.

 

First, the company enjoys very high visibility into future earnings thanks to its long-term leases with wireless service providers.

 

Almost all of American Tower’s leases are non-cancellable and usually include an initial term of at least 5-10 years with multiple 5-year renewal periods.

 

Price escalators are embedded into American Tower’s leases as well, with the U.S. averaging 3% annual price increases and international markets’ escalators typically based on local inflation indices. These predictable gains provide a dependable base for organic growth.

 

The company currently has commitments of approximately $31 billion in non-cancellable tenant lease revenue, which provides great visibility because that amount is worth more than five times the company’s 2016 property revenue.

 

You can also see that two-thirds of American Tower’s global leases are not up for renewal until at least 2021, further reducing the potential for surprises any single year.

 

 

When leases have come up for renewal, the company has historically enjoyed 98-99% annual renewal rates based on property revenue, reflecting the  limited alternative sites that tenants have to choose from when their leases come up for renewal (regulation and zoning requirements help limit supply).

 

Another reason why American Tower enjoys such strong renewal rates is because it’s cheaper for wireless carriers to outsource their communications site infrastructure needs rather than build and operate their own tower sites.

 

By spinning off their towers to companies such as American Tower, wireless service providers free up capital that can be used to pay down debt and reinvest in their networks’ quality, which is core to their businesses.

 

American Tower has historically benefited from wireless carriers exiting the operations of their tower sites.

 

For example, the company acquired exclusive rights to lease and operate more than 11,000 wireless communications towers from Verizon in 2015 for approximately $5 billion.

 

These towers had existing average tenancy of 1.4 tenants per tower, well under their available capacity.

 

Other notable deals include American Tower’s purchase of a controlling stake in Viom Networks, an Indian cell tower company, for $1.2 billion in 2015.

 

The company also entered into Nigeria, Africa’s most populous country, in a $1 billion deal in 2014.

 

American Tower can capture incremental leasing activity on these assets and spread its fixed costs over a greater number of towers, driving its returns on invested capital higher over time.

 

Adding additional tenants and equipment to existing towers is extremely profitable, with incremental gross margins of 97%.

 

In fact, the company’s return on investment for each tower increases from 3% with one tenant to 13% and 24% with two and three tenants, respectively.

 

Unlike many REITs, American Tower’s maintenance capital expenditure needs are very low, too. Maintenance spending is expected to total $160 million in 2017, which represents less than 3% of American Tower’s 2016 revenue ($5.8 billion).

 

As a result, the company has been a free cash flow machine over the years:

 

 

With a global average of 1.9 tenants per tower (less than half of available capacity), the company has substantial room available to add future tenants.

 

As American Tower gradually fills out its towers around the world, its assets will likely earn significantly higher returns on capital because the incremental cost of adding a new tenant or additional equipment to an existing tower is very low.

 

Roughly 30% to 40% annual growth in mobile data traffic in the U.S. and the increased adoption of smartphones around the world is fueling the need for wireless carriers to continue investing in their networks’ density to meet demand.

 

 

This is particularly true in markets outside of the U.S., where smartphone penetration in many regions is less than 50% today.

 

The technologies deployed in most emerging markets are oftentimes 2G and 3G (i.e. much less advanced than those in the U.S. market), and American Tower’s occupancy rates are low by design, about 1.5 tenants per tower.

 

Wireless service providers in these markets will need to invest more in their networks to expand and improve their coverage, and increased adoption of wireless data applications (e.g. email, internet, video) and lower cost smartphones will put further upward pressure on network spending.

 

As you can see below, most developing and evolving markets significantly trail the U.S. in both wireless penetration rates and mobile broadband (3G/4G) penetration.

 

 

Closing this gap will take years, if not decades, but American Tower’s strategically-located infrastructure is positioned nicely for the increasing proliferation of wireless devices and the increasing usage of high bandwidth applications on those devices.

 

The company’s presence in many different markets that are in different stages of wireless development provides healthy diversification as well.

 

While management expects 5% to 7% annual growth in the U.S., which accounts for roughly 75% of operating profits today, you can see that international organic tenant billings growth more than doubled that of the U.S. in 2016:

 

 

With over 70% of its communications sites located internationally, American Tower is positioned to benefit from higher network spending over the coming years and decades.

 

Riding this secular trend should hopefully enable American Tower to continue delivering double-digit adjusted funds from operations (AFFO) per share growth, just like it has done for nine consecutive years.

 

While there are numerous strengths to American Tower’s business, several notable challenges could arise in the future.

 

Key Risks

While fluctuating foreign currency exchange rates and volatile network infrastructure spending by wireless service providers can impact American Tower over the short-term, these issues are unlikely to impair the company’s long-term earnings power.

 

The primary risks that could structurally disrupt American Tower’s future are technological changes, customer consolidation, and the success of management’s capital allocation strategy.

 

Starting with technology, American Tower is obviously dependent on wireless service providers continuing to need its towers to transmit communication signals.

 

Network deployments today generally consist of multiple layers—traditional macro cell towers (like the ones American Tower leases out) provide a blanket of coverage, while a combination of other technologies (i.e. small cell) are also used to increase network capacity, especially in dense urban areas.

 

 

The smartphone boom and widespread move to 4G wireless technology by U.S. carriers drove substantial demand for more macro sites (i.e. towers) over the last decade.

 

 

With many carriers now looking to 5G wireless technology, there is some uncertainty about what the final architecture and standards will look like – and how important tower sites will be.

 

We are still years away from the 5G standard being officially defined, much less deployed on a wide scale basis, but there is speculation that some infrastructure investment could shift to fiber and small cells to meet the density requirements of 5G.

 

This would potentially reduce the role of traditional towers in certain areas and threaten the favorable economics they enjoy today.

 

You can read more about how the tower companies are responding to this potential threat here. Not surprisingly, American Tower does not believe these new technologies are a viable alternative to towers but can complement them in certain cases, such as densely populated areas.

 

Less than 1% of the company’s towers are in locations with at least 10,000 people per square mile, so there is presumably little threat to American Tower’s legacy business under this assumption.

 

It’s also worth pointing out that over 80% of the U.S. population lives in suburban or rural areas, where more than 95% of the company’s U.S. towers are located.

 

These areas seem like less of a fit for small cell deployments, and continued growth in international wireless markets over the coming years can help American Tower continue diversifying away some of the 5G technology risk in the U.S.

 

Somewhat related to technology risk, it’s no secret that the major wireless carriers in the U.S. are struggling to growth their revenue.

 

Their lack of growth is causing them to more closely scrutinize their deals with tower companies, which enjoy strong economics today.

 

According to Steel In The Air, “wireless carriers aren’t sitting idly by but are instead actively seeking to relocate some of their more expensive sites. Whether these efforts are selective and focused primarily on “scaring” the tower companies, or they represent actual and significant savings on operating expenditures going forward, we don’t know. Either way, we believe that there will be clear proof of the extent of these efforts in 2017 and that this will negatively impact the tower companies.”

 

American Tower’s scale, lease renewal schedule, and geographic diversification help, but this is still a risk to keep in mind.

 

Similarly, tower companies can be adversely affected when carriers merge together, which allows the combined companies to rationalize overlapping parts of their networks, share equipment, and decide not to renew certain leases.

 

A possible merger between Sprint (10% of American Tower’s total revenue) and T-Mobile (8%) has long been speculated, for example.

 

Fortunately, Sprint and T-Mobile only have 4% revenue overlap on American Tower’s sites today, and those contracts have five to six years to run. In other words, there would likely be minimal impact if such an event occurred.

 

Furthermore, citing the Sprint-Nextel, AT&T-Cingular, and Verizon-Alltel mergers, American Tower claims it has enjoyed 20-25% more business from each combined entity 12 to 18 months after the deal compared the amount the company was receiving from the individual entities.

 

How can this be? Essentially, the combined company now has to service an even broader base of customers, even on overlapping towers. Combining businesses also tends to result in more capital that can be reinvested in the network for the long-term.

 

International wireless markets are much more fragmented, so this could be a bigger risk in those regions. Furthermore, American Tower’s customer concentration also makes it dependent on the financial health of wireless service providers.

 

The final major risk to consider is management’s capital allocation decisions. American Tower has made a number of major acquisitions in recent years, stretching the company’s balance sheet while deepening its presence in a number of international markets (including India and Nigeria).

 

It’s extremely important that American Tower can generate strong returns from international markets as they continue maturing and capacity fills up on the company’s tower sites.

 

You can see that yields on American Tower’s long-standing international builds are very favorable, and its more recent sites need to follow a similar trajectory for the long-term growth story to hold.

 

 

American Tower’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

American Tower’s Dividend Safety Score of 96 suggests that its dividend payment is one of the safest in the market.

 

The company’s dividend safety begins with its payout ratio. American Tower’s dividend consumed less than 40% of the company’s adjusted funds from operations (AFFO – the equivalent of free cash flow for REITs) in 2016, providing a very healthy coverage ratio.

 

Unlike most REITs, American Tower generates excellent free cash flow, which further enhances the safety of its dividend.

 

As the company continues adding tenants to its existing tower base, revenue will continue rising while costs remain relatively flat, further increasing free cash flow generation.

 

The company’s services are also non-discretionary in nature because wireless carriers need to continue providing network coverage even during recessions (and don’t forget about American Tower’s long-term, non-cancellable leases with annual price escalators).

 

Finally, it’s very important to review a company’s balance sheet when evaluating the safety of its dividend.

 

At first glance, American Tower’s balance sheet looks a little scary, driven by several large acquisitions made over the last few years.

 

The company holds over $18 billion in debt and has a debt to capital ratio above 70% (my preference is 50% or less for most types of businesses).

 

 

However, American Tower maintains an investment-grade BBB- credit rating from S&P and has approximately $2.8 billion available under its credit facilities.

 

The company’s near-term debt maturities are also very manageable with less than $2 billion per year due each year through 2021.

 

Over 80% of the company’s debt is fixed as well, somewhat insulating it from rising interest rates.

 

While the company certainly carries a lot of debt and will likely continue to be acquisitive, its cash generation, credit rating, and availability under its credit facilities mitigate most concerns.

 

Overall, American Tower’s healthy payout ratio, consistent free cash flow generation, and steady and predictable revenue stream support the safety of its dividend.

 

American Tower’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

American Tower’s Dividend Growth Score is 91, meaning that dividend investors can likely continue to expect very strong payout growth going forward.

 

The company has increased its dividend every quarter since it began making payments in 2012, nearly tripling its payment while recording 25.4% annualized dividend growth over the last three years.

 

 

Looking forward, management expects to grow American Tower’s dividend by at least 20% per year.

Valuation

AMT’s stock trades at a forward P/AFFO multiple of 19.1 and offers a dividend yield of 2.0%, which is above the stock’s five-year average dividend yield of 1.4%.

 

AMT’s multiple isn’t cheap, but it recognizes the company’s secure cash flow and long-term growth opportunities in international markets.

 

If the company can continue delivering high single-digits to low double-digits annual growth in AFFO per share, AMT’s stock has potential to deliver a 10-12% annual total return over the coming years (2% dividend yield plus 8-10% annual AFFO per share growth).

 

I generally prefer not to pay more than 15-20x cash flow when I buy a company, and AMT’s multiple is near the upper bound of my target range.

 

However, given the company’s favorable business quality and impressive growth profile, I think American Tower is reasonably priced for long-term investors.

 

Concluding Thoughts on American Tower

For investors seeking long-term dividend growth and capital appreciation, American Tower appears to be an interesting candidate to consider.

 

The economics of the tower business are quite favorable, and the earnings potential of American Tower’s existing tower base in developing markets is substantial.

 

Investors disappointed by American Tower’s 2% dividend yield (although your yield on cost will increase quickly with 20% annual dividend growth) can consider Crown Castle (CCI), another wireless tower company that yields 4% and is a position in Bill Gates dividend stock portfolio.