American Tower (AMT) has an admirable performance record. It has grown its funds from operations in 9 of the last 10 years and has raised its dividend in every single quarter since 2012. It is also a major holding (12.2%) of Akre Capital Management, which is well known for its focus on stocks with extraordinary business, talented management, and ample room to grow.

American Tower seems fairly valued right now, but the company has above-average growth potential for a REIT, all while providing shareholders with an attractive 2.3% dividend yield.

Image Source: Pexels

Business overview

Founded in 1995, American Tower is one of the largest Real Estate Investment Trusts (REITs) in the world. It owns, operates, and develops multitenant communications real estate, with an asset portfolio of approximately 181,000 communication sites, in the U.S. and abroad.

American Tower has proved resilient to the severe global recession, which has resulted from the pandemic. In the most recent quarter, the company grew its revenue by 3% and its adjusted funds from operations (AFFO) per share by 14.5% thanks to solid organic growth throughout its business and a lower tax rate.

Thanks to its strong business momentum, American Tower raised its guidance for its AFFO per share in the full year by 3%, to an all-time high level of $8.34-$8.45. The all-time high results amid the pandemic prove the defensive nature of American Tower.

Growth Prospects

American Tower is a leader in the U.S. market and has also expanded significantly in international markets. The company has grown its AFFO per share in 9 of the last 10 years, at an impressive 14.9% average annual rate over the last decade. The key factor behind this exceptional growth record is a strong secular trend, namely the sustained increase in data usage. As international markets have lagged the U.S. in this trend, this tailwind is likely to remain in place for American Tower for years.

Moreover, American Tower recently signed a new 15-year agreement with T-Mobile. This agreement includes annual escalators of 3.0%-3.5% and is expected to increase the revenues of American Tower by $17 billion throughout the duration of the agreement. Given that the REIT currently generates annual revenues of $7.8 billion, this contract is likely to be a meaningful growth driver in the upcoming years.

On the other hand, American Tower has some headwinds ahead, such as the consolidation of major carriers. For instance, the merger of Sprint (S) and T-Mobile (TMUS) is likely to reduce redundant networks and thus take its toll on the revenues of American Tower. In addition, the rollout of 5G is likely to weigh on the tower business model of American Tower.

Overall, we find it prudent to assume a 6.0% average annual growth of AFFO per share over the next five years. This assumption may seem conservative when compared to the aforementioned historical growth rate of the REIT but it seems warranted given the fast-changing landscape in the telecommunications sector.

Dividend Analysis

American Tower is currently offering a 2.3% forward dividend yield, which is above the broader market average. American Tower has a relatively short dividend growth record, as it has raised its dividend for 8 consecutive years. On the other hand, the company has raised its dividend in every single quarter in the last eight years. Due to the fast pace of dividend raises, American Tower has essentially quintupled its dividend in the last eight years.

The payout ratio is still healthy, at 54%, but the REIT has a somewhat weak balance sheet, with a ratio of net debt to adjusted EBITDA of 4.5. Overall, despite its lackluster current yield, the stock may be suitable for income-oriented investors who have a long-term investing horizon, though investors should not expect the dividend to continue growing at its historical rate.

Valuation – Expected Return

American Tower is currently trading at a price-to-AFFO ratio of 25.6, which is higher than the average AFFO multiple of 23.0 of the stock over the last decade. Given the growth prospects of the REIT and the aforementioned headwinds, we assume a fair price-to-AFFO ratio of 22.0 for the stock. If American Tower trades at our assumed fair valuation level in five years, it will incur a 3.0% annualized drag in its returns.

Given the expected 6.0% annual growth of its AFFO per share, its 2.3% dividend, and a 3.0% annualized contraction of its valuation level, American Tower is likely to offer a 5.1% average annual return over the next five years. This is not an extremely high rate of return but would represent a satisfactory holding for dividend growth investors.

Final thoughts

American Tower has a consistent growth record and ample room for future growth. However, the company is not likely to keep growing at its recent pace while the stock seems fully valued right now. As a result, investors should probably wait for a meaningful correction of the stock before purchasing it. Still, American Tower is a high-quality stock for a safe dividend and reliable dividend growth.