For most of the last two years – even before the pandemic started – one of the areas that I have been able to find some interesting valuations to work with have come from the Telecommunications industry. Some of the largest players in the industry do much more than just telecommunications; AT&T Inc. (T) has, of course long been one of the largest telecomm companies in the United States, which has also gave them the ability to branch out and diversify their business into the entertainment world. 2020 has proven to be a challenging year for many of this “diversified telecomm services” company’s businesses; that has helped to keep the stock price relatively low for the last year, but the latest earnings report shows some serious signs of deterioration that a material recovery could take longer than expected.
In 2015, the company acquired DirecTV, a segment that has struggled for the last couple of years, following a longer-term theme as consumers are increasingly “cutting the cord” on traditional cable or satellite TV services. T has been looking to sell DirecTV, along with other underperforming segments to private equity investors, and recently completed a deal for a minority stake in those segments to create a new company operating DirecTV, U-verse and AT&T TV – but compared to the $49 billion it paid in 2015, the $7.8 billion it got in the deal, while still retaining a majority stake of the new company, it may seem like an admission of how disastrous that deal really was. In 2018, T’s acquisition of Time Warner gave it a foothold in the same space occupied by media companies like Viacom and Disney – but a lot of people are saying that a new deal, to spin off the WarnerMedia unit into a new company merged with Discovery, is a sign that AT&T is admitting it made another bad decision with that acquisition. I think it is worth noting that T will receive $43 billion that will be used to reduce debt, and still retain 71% ownership of the new company. For this and the DirecTV sale, the company clearly appears to be betting on the long-term return return of its investment with short-term proceeds being used to help reduce debt while it turns its primary focus back to its core telecomm expertise.
T is an interesting mix of opportunity and risk right now, as the company continues to emerge from a pandemic that forced a practically complete shutdown of all WarnerMedia production, and which put the company’s operating margins into negative territory over the last year. That reality provided a dark cloud that many analysts have seem to fixate on, even as economic activity has indicated that the company is starting to emerge from that challenging period with material gains in Net Income, along with still-healthy Free Cash Flow and improving liquidity. Are the those strengths enough to make T’s stock a good bet for a long-term, value-oriented investor?
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 three segments: Communication segment, WarnerMedia segment, and Latin America segment. The Communications segment provides wireless and wireline telecom, video and broadband services to consumers. The business units of the Communication segment includes Mobility, Business Wireline and Consumer Wireline. The WarnerMedia segment develops, produces and distributes feature films, television, gaming and other content over various physical and digital formats. WarnerMedia segment also includes Xandr, which provides advertising services. Latin America segment provides entertainment and wireless services outside of the United States. Mexico is the business unit of the Latin America segment, which provides wireless service and equipment to customers in Mexico. T has a current market cap of about $162.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 14.5%, while revenues declined by -5.7%. In the last quarter, earnings were -2.25% lower, while revenues -9.36% lower. T operates with an operating profile that sunk into negative territory during the pandemic but has been showing significant improvement over the last couple of quarters. Over the last twelve months, Net Income was 0.67% of Revenues, and strengthened to 14.82% in the last quarter.
Free Cash Flow: T’s free cash flow is healthy, at nearly $25.7 billion. This number has increased steadily since early 2015, from about $10 billion. The current number translates to a useful Free Cash Flow Yield of 15.76%.
Dividend: T’s annual divided is $2.08 per share, which translates to a compelling, but temporary yield of 9.11% at the stock’s current price. It should be noted that management intends to cut the dividend after the WarnerMedia spinoff is completed (expected sometime in 2022) to reflect the smaller size of the remaining company.
Debt/Equity: T carries a Debt/Equity ratio of .86, which is generally considered a pretty conservative number that doesn’t really paint a complete picture. Their balance sheet shows $21.2 billion in cash and liquid assets versus $155.6 billion in long-term debt. Much of that debt is associated with the Time Warner acquisition. The spinoff will pay down a portion of that amount, but still leave more than $100 billion. As with other companies in this industry, T has also historically carried a lot of debt, with more than $100 million in long-term debt on the books since mid-2015. T’s healthy Free Cash Flow and improving Net Income indicate they should have no problem servicing the debt they have.
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 at a little above $29 per share. That suggests that the stock is undervalued, with 27% upside from its current price. It is also worth noting that prior to the latest earnings report, this same analysis yielded a “fair value” target price at around $33 per share.
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 May peak at around $34 to its low, reached at the beginning of this month at around $22; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. After consolidating in September between $27 and $28 in September, the stock has broken down even further as broader market uncertainty has increased since Thanksgiving. The stock found current support at around $22, with immediate resistance at around $24. A push above $24 should have upside to about $26 to next resistance, while a drop below $22 could fall to around $20 before finding next support, based on the current distance between support and resistance levels.
Near-term Keys: T offers a high dividend that makes for tempting bait for income-seeking investors; but don’t ignore the fact that the dividend will be reduced in 2022 once the WarnerMedia spinoff has been completed. The market has pushed this stock to levels not seen in a decade, despite the generally improving fundamentals the company has reported over the last few quarters, and that is one of the main reasons T’s value proposition is attractive right now. For practical purposes, the stock would need to push above $25 to signal a reversal of the current downward trend; that would be the best signal to consider buying the stock or working with call options, with possible upside in that case to between $27 $28 where the 38.2% retracement line currently sits. A drop below $22 could be used to consider shorting the stock or buying put options, so long as you intend to work with very short profit targets; the stock’s next expected support around $20 means opportunity on the downside is very limited.