One of the more interesting narratives throughout the year from a functional standpoint as an investor is where the most profitable opportunities have been found this year, even as businesses across the world have been forced to shut down, or at best, significantly adjust the way they do business. When you consider the sheer scope of the shift to a work-at-home model for much of corporate America, you have to start to account for reality that for many companies this is becoming a permanent way to operate. Even when coronavirus eventually comes to an end, I think there will be a major portion of corporate America that continues to work remotely, simply because the model has proven more cost-effective than many people expected, and at least as productive as working in-office, if not more so. That’s why I don’t think it’s too surprising to see that most of the stocks that have offered the most dramatic upside this year are those that were already positioned to facilitate productive, work-at-home operations. Another successful segment are companies that offer services – entertainment, in particular – that can help blunt the social and emotional impact of self-isolation, which including video gaming stocks, streaming services, and so on.
In that vein, I think AT&T Inc. (T) occupies an interesting, if under-appreciated spot in today’s economy. T has, of course long been one of the largest telecommunications companies in the United States, which has also given them the ability to branch out and diversify their business into the entertainment world. In 2015, the company acquired DirecTV, which in the last quarter was a portion of the business that underperformed, following a longer-term theme that has gone on for a couple of years as consumers are increasingly “cutting the cord” on traditional cable or satellite TV services. Rumors suggest that T is looking to sell DirecTV to private equity investors, but would be unlikely to recoup the $49 billion it paid (latest estimates put final expected bids from unnamed, interested parties in the $15 billion range). In 2018, T’s acquisition of Time Warner gave it a foothold in the same space occupied by media companies like Viacom and Disney. The telecommunications side continues to promise to be a long-term catalyst, as T has been investing heavily for years in 5G wireless spectrum, development and implementation.
More recently new rumors emerged that T was considering a sale of its Warner Bros. Interactive Entertainment gaming division, a transaction that could bring in $4 billion to help the company pay off new debt the company took on in the wake of COVID-19 that included costs to protect employees and a forced shutdown of WarnerMedia. Another potential headwind is the company’s launch of its own streaming service, HBO Max, a late entry into a streaming video business that is becoming more and more congested and competitive. HBO Max is priced at a premium versus competitors like Disney+, Amazon Prime or Netflix, and begs the question of how much market share the service will bring in. Results from new subscriptions to that service so far have been mixed. Even with those headwinds, however, there are also some interesting strengths to consider, including a balance sheet that has remained relatively strong throughout the year even in the midst of an almost complete shutdown of the WarnerMedia unit during the initial outbreak. A month ago, I wrote in the space my opinion that T was an under-appreciated, good long-term value, a little ahead of the company’s next earnings release, which came out in late October. Factoring a new set of quarterly data means that the value proposition has gotten stronger in just a few weeks’ time. Let’s dive in.
Fundamental and Value Profile
AT&T Inc. is a holding company. The Company is a provider of telecommunications, media and technology services globally. The Company operates through four segments: Communication segment, WarnerMedia segment, Latin America segment and Xandr segment. The Communications segment provides wireless and wireline telecom, video and broadband services to consumers.The business units of the Communication segment includes Mobility, Entertainment Group and Business Wireline. The WarnerMedia segment develops, produces and distributes feature films, television, gaming and other content over various physical and digital formats. The business units of the WarnerMedia segment includes Turner, Home Box Office and Warner Bros. Latin America segment provides entertainment services in Latin America and wireless services in Mexico. Viro and Mexico are the business units of the Latin America segment. The Xandr segment provides advertising services. T has a current market cap of about $203.2 billion.
Earnings and Sales Growth: Over the last twelve months, earnings shrank by about -19.15%, while revenue declined about -5%. In the last quarter, earnings were -8.43% lower, while revenues grew 3.39%. T operates with an operating profile that had narrowed throughout the year, which isn’t surprising given the pattern of declining revenues and earnings, but started to stabilize, and even strengthen a bit in the last quarter. Over the last twelve months, Net Income was 6.42% of Revenues, and weakened to a little over 6.65% in the last quarter.
Free Cash Flow: T’s free cash flow is very strong, at more than $27.9 billion. This number has increased steadily since early 2015, from about $10 billion, but has dropped from the beginning of 2020, when it was about $29.2 billion. Over the last quarter, however, Free Cash Flow improved from $25.9 billion. The current number translates to a useful Free Cash Flow Yield of 13.6%.
Dividend: T’s annual divided is $2.08 per share, which translates to a compelling yield of 7.24% at the stock’s current price.
Debt/Equity: T carries a Debt/Equity ratio of .78, which is generally considered a pretty conservative number that doesn’t really paint a complete picture. Their balance sheet shows nearly $9 billion in cash and liquid assets versus nearly $153 billion in long-term debt. Much of that debt is associated with the Time Warner acquisition, and which is expected to be paid down in the long run; but being forced to shut down the WarnerMedia segment due to COVID-19-imposed restrictions earlier this year also forced the company to realize additional short-term costs of nearly $500 million that haven’t been offset by revenues.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $36 per share. That also suggests that, the stock is undervalued right now, with about 25% upside from its current price. It is worth noting, however, that at the end of the second quarter my Fair Value target for T was closer to $40.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from a November 2019 peak near $40 to its low in mid-March around $26; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. From the low, the stock rallied to about $33 early in June before dropping back to a consolidation range between $29 and $30 per share. The stock dropped below that range in September, and news reports that film studios continue to delay theatrical movie releases into 2021 is certainly acting as a negative pressure point that pushed the stock below $27 in late October. Current support is now around $28, with resistance at $29. The stock would realistically need to push above the 38.2% retracement line a little above $31 to form a new upward trend, while a drop below $28 would likely prompt the stock to test its bear market low around $26.
Near-term Keys: T offers an interesting value proposition, and a high dividend that makes for tempting bait for both value and fundamental-oriented investors. Given the way the stock hasn’t followed the trend of many of its brethren to revisit pre-pandemic highs, however, I wonder that some of the other elements at play right now aren’t working against the stock’s value argument in the broad market. In particular, I think that movie and television production – most particularly as it applies to new theatrical movie releases – are going to act as a leading indicator for T’s Warner Media segment, which has provided the biggest headwind holding the company back right now. I think, however that T could be a great long-term opportunity to invest in a company with improving fundamentals at relatively cheap prices. If you prefer to focus on short-term trading strategies, you could use a break above $29 to consider buying the stock or working with call options, using $31 as a quick-hit profit target, and $33 around the stock’s June high if bullish momentum continues. A drop below $28 could act as a signal to consider shorting the stock, using its bear market low around $26 as a bearish profit target.