The market always has the tendency to overreact. Be it euphoric rallies or sharp corrections, investor behaviour is not always rational. However, for smart investors, it’s the deviation from fundamentals that provides an opportunity to make big money. The focus of this column is on undervalued dividend stocks that are worth considering at current levels.
An important point to note is that the dividend stocks discussed represents companies with strong or significantly improving fundamentals. However, these stocks have been ignored by the markets. When these dividend stocks with a yield of over 5% are in the limelight, the rally can be sharp.
In my view, if we take a two-to-three-year investment horizon, these undervalued dividend stocks are likely to outperform the index. I also see the possibility of steady dividend growth. Let’s therefore discuss the reasons that make these ideas worth holding for the medium term.
AT&T (T)
After an extended period of correction and consolidation, AT&T (NYSE:T) stock has been silently moving higher. However, even after an upside of 20% in the last six months, T stock is undervalued. Further, the stock offers an attractive dividend yield of 6.51%.
There are two reasons to be bullish on AT&T. First, the Company reported healthy free cash flows of $16.8 billion for 2023. For this year, AT&T has guided for FCF of $17 to $18 billion. With the Company focused on deleveraging, robust FCF will ensure that the target is met. Also, as credit metrics improve, the stock will be re-rated.
Further, AT&T has made some big investments in the last five years towards the wireline and wireless infrastructure. In my view, this will continue to yield positive business metrics numbers. For 2023, AT&T reported steady growth in phone and fiber subscribers. With a strong 5G coverage, I expect user growth to sustain.
Rio Tinto (RIO)
Among industrial commodity stocks, Rio Tinto (NYSE:RIO) looks massively undervalued at a forward price-earnings ratio of 7. RIO stock also offers a robust dividend yield of 8.23% and I believe that dividends are sustainable.
The reason for RIO trading at a valuation gap is macroeconomic headwinds. However, it’s worth noting that potential rate cuts are impending globally in the second half of 2024. Expansionary policies are likely to support growth in 2025 and beyond. Therefore, it’s a good time to accumulate RIO stock.
Another point to note is that Rio Tinto has strong fundamentals. Last year, the Company reported operating and free cash flow of $15.2 billion and $7.7 billion respectively. This provides high flexibility for investment to boost growth. Between 2024 and 2026, Rio has guided for annual capital expenditure of $7 billion.
Rio is also investing in decarbonisation theme metals. This includes copper, aluminium, nickel, and lithium. With diversification, the Company is positioned for steady growth.
Flex LNG (FLNG)
Flex LNG (NYSE:FLNG) is a provider of seaborne transportation of liquefied natural gas globally. After a correction of 22% in the last 12 months, FLNG stock looks attractive at a forward price-earnings ratio of 11.6. Further, the dividend yield is robust at 11.77% and the Company is well placed from a financial perspective to sustain dividends.
The biggest positive for Flex LNG is high contract coverage. As of Q4 2023, the Company’s fleet had a combined charter backlog of 50 years. If the contract extensions are exercised, the backlog will swell to 71 years. Therefore, there is clear cash flow visibility for dividends.
Another point to note is that Flex LNG has a strong balance sheet. The net-debt was $1.4 billion as of Q4 2023 with no maturities until 2028. Debt servicing is unlikely to be a challenge with stable cash flows. Further, a loan-to-value of 81.7% provides scope for leverage in a scenario of new vessel acquisition.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
