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AT&T (T) is a mammoth of a company that continues to gobble up more control of our media and communications. Investors are uncertain as to how the Time Warner (NYSE:TWX) deal will affect this company’s long-term future. There are definitely uncertainties, but this article will focus on the facts and will reveal that AT&T is not the stable and consistent investment that it portrays through its brand history and steady dividend payments. We’ll also look closely at its real value compared to stock price. The conclusion will be shocking for some shareholders, while other patient, long-term investors might still be satisfied with holding it long term.
Snapshot of the Company
A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer’s company rating score. It shows a score of around 68/100. Therefore, AT&T isn’t considered to be a good company to invest in, since 70 is the lowest good company score. AT&T has high scores for Ability to Recover from a Market Crash or Downturn and Gross Margin Percent. It has better than average scores for 10-year Upward Price Per Share and EPS history. Lacking categories are Return on Equity, Return on Invested Capital, and PEG Ratio.
These findings could indicate that AT&T might be a somewhat difficult business to predict since it is not showing good scores in many categories.
Before jumping to conclusions, we’ll have to look closer into these categories to see what’s going on.
(Source: BTMA Stock Analyzer - company rating scores)
Fundamentals
Let’s examine the price per share history first. In the chart below, we can see that price per share has experienced most of its growth after the economic crisis, from 2009 to 2013. But for the past 8 years, the share price average has been more up and down. But overall, share price has been increasing over the past 10 years.
(Source: BTMA Stock Analyzer – Price Per Share History)
Looking closer at earnings history, we quickly see that it’s been a rough ride over the past 10 years. Earnings are highly inconsistent, which makes it harder to accurately estimate the future growth and value of the company.
(Source: BTMA Stock Analyzer – EPS History)
Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors like the gross margins, Return on Equity, and Return on Invested Capital.
The return on equity history is inconsistent and varies to large degrees from a low average of around 7% to a high average of around 22%. One positive thing is that ROE has been increasing overall from 2014-2017.
(Source: BTMA Stock Analyzer – ROE History)
Return on Invested Capital average has been sub-par for the past 5 years and it also correlates with the inconsistencies of the Return on Equity. If a company cannot consistently maintain or increase returns on equity and invested capital, then investors are likely taking a gamble by investing in this company with no real expectation of a regular return of value. At best, they would need to hope for a consistent dividend.
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(Source: BTMA Stock Analyzer – Return on Invested Capital History)
AT&T’s Gross Margin Percent history has ironically been impressive and depressing at the same time. I typically look for consistent gross margins of over 30%, which AT&T has easily maintained. In 2013, they were at double this rate, and over the past 5 years, they’ve been at rates of 52%-60%. The high gross margins support that AT&T provides a high-profit potential service. On the negative side, the gross margins have been decreasing for the past 5 years.
(Source: BTMA Stock Analyzer – Gross Margin Percent History)
From this factual data, we can see that this stock is showing weaknesses and inconsistencies in several categories despite the company’s high gross margins and profit potential. If I were a present shareholder, I would be concerned with AT&T’s lack of consistency, decreasing margins, and inability to produce high returns on invested capital.
(Source: BTMA Stock Analyzer – Misc. Fundamentals)
Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is at a good level, especially for a company of this size. AT&T ranks as #5 of America’s largest companies.
AT&T’s Current Ratio of 1.11 is reasonable, telling us that it still has enough assets to pay off short-term debts.
According to the balance sheet, the company seems to be in a healthy financial position.
The Price-Earnings Ratio is at 6.4. This is lower than the 5-year and 10-year average normalized PE ratio of around 15-18. This tells me that the market may have AT&T undervalued when considering the current PE Ratio to the past average PE Ratio.
The Story Behind The Dividend
If you’re currently holding AT&T for its dividend, then this section should be useful for you. First, I’m interested in knowing if the payout ratio is sustainable. At this time it’s around 40%, which means that there is still room to grow the dividend. However, the payout ratio has not been consistent and AT&T has a history of buying back stocks, which contributes to higher payout ratios. Although payout ratios are high regardless of buybacks, AT&T seems to maintain a healthy financial situation and an ability to continue with high payouts to shareholders.
Now, let’s remove the buybacks from the equation to have a clearer look at the still inconsistent dividend payout ratio in the chart below.
Next, I’m interested in dividend per share. Typically, I’d want to see a dividend per share that is steadily growing each year. The dividend per share has been increasing steadily over the past 8 years by about 2% annually. The growth is not great, but at least it’s consistent. Also, I’d like to know that the dividend per share is following along well with the earnings and cash flow. From the graph below, we can see that… yes, overall dividends per share, cash flow, and earnings have increased. However, the paths to get there have been non-linear and highly unpredictable from year to year. From a 10-year view, you could say that all is well because earnings, dividends, and cash flows are increasing, but as an alert shareholder during each of those 10 years, you were likely on a wild ride of highs and lows, not knowing what the next earnings report was going to surprise you with.
If I were currently interested in buying AT&T now for the dividend, I would be trying to buy when the dividend yield was highest relative to its past. From the chart below, we can see that the dividend yield is near its highest point relative to the past 7 years. Therefore, it could be a good time to buy now if my priority is a better than average return through dividends.
Overall, the dividend situation with AT&T is better than average. First of all, a dividend yield of over 6% is attractive for long-term investors. The company has been consistently increasing dividends over the past 10 years by about 2%, and the dividend yield is at a high level compared to the past. The drawbacks are that the payout ratio is typically high and so erratic because of inconsistent earnings.
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This analysis wouldn’t be complete without considering the value of the company vs. share price.
Value Vs. Price
For valuation purposes, I will be using EPS TTM of 4.94. I’ve used various past averages of growth rates and PE Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.
In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.
According to this valuation analysis, AT&T is undervalued in multiple categories.
- If AT&T continues with a growth average similar to its past 10 years' or past 5 years' earnings growth, then the stock is undervalued at this time.
- If AT&T continues with a growth average similar to its past 5 years' book value growth and equity growth, then the stock is undervalued.
- According to AT&T’s typical PE ratio relation to the S&P 500's PE Ratio, AT&T is undervalued.
- If AT&T continues with a growth average as forecasted by analysts, then the stock is undervalued.
This analysis shows an average valuation of around $55 -$56 per share.
Forward-Looking Conclusion
According to the facts, AT&T seems to have a decent financial balance sheet, its dividend situation is better than average, and the stock is undervalued, but AT&T’s inconsistencies make it a more unpredictable investment, which is difficult to estimate value and future growth. Here is a recap of the pros and cons.
CONS:
- Earnings haven't been very consistent over past 10 years or past 5 years.
- ROE has not been consistent over the past 5 years. 2017 ROE is more than double 2016 ROE, indicating that some major changes are taking place with the business.
- ROIC situation is similar to ROE situation. Both are inconsistent and 2017 ROIC is almost double 2016 ROIC.
- Gross margins have been steadily decreasing over the past 5 years.
PROS:
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- Balance sheet looks good with decent Debt to Equity and decent Current Ratio.
- PE Ratio is very low, indicating that the stock could be undervalued.
- Dividend Yield TTM is attractive at 6.28% and is near a 7-year high.
- Dividends per share have been growing consistently by about 2% over the past 10 years.
- Valuation analysis shows that AT&T is undervalued.
Predicted Growth
Analysts predicted short-term growth until December 2018 is 11.85%, but long-term (5-year) growth rate is predicted at 3.42%. As according to NASDAQ: “Over the next five years, the analysts that follow this company are expecting it to grow earnings at an average annual rate of 3.42%. This year, analysts are forecasting earnings increase of 14.67% over last year. Analysts expect earnings growth next year of 1.14% over this year's forecasted earnings.” (Source: AT&T Inc. Forecast Earnings Growth)
If you invest today, with analysts’ forecasts, you might expect at best about 3.5% growth per year. Plus we’ll add the current 6.36% forward dividend. This brings the annual return to around 9.86% and this is probably a best-case scenario.
An alternative scenario produces similar results: During the past 10- and 5-year periods, the average EPS growth rate was about 8.5%. Plus the average dividend yield was about 4.5%. So we’re at a total return of 13%. But when we factor in the share price change, there was a loss of 3% per year in share price over 5 years. Therefore, our annual return would be around 10%.
If considering actual past results of AT&T, which includes the inconsistent earnings, affected share prices, and long-term dividend yields, the story is a bit different. Here are the actual 10- and 5-year return results.
10-Year Return Results if Invested in AT&T: Initial Investment Date: 07/19/2008; End Date: 07/19/2018; Cost per Share: $32.12; End Date Price: $31.27; Total Dividends Received: $18.10; Total Return: 53.92%; Compound Annualized Growth Rate (CAGR): 4%
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5-Year Return Results if Invested in AT&T: Initial Investment Date: 07/19/2013; End Date: 07/19/2018; Cost per Share: $35.81; End Date Price: $31.27; Total Dividends Received: $9.55; Total Return: 14.19%; Compound Annualized Growth Rate (CAGR): 3%
From these scenarios, we have produced results from 3% to 10%. I feel that if you’re a long-term patient investor, you could expect AT&T to provide you with a 10% annual return if you wait for the right time to sell. But for the short-term or impatient investor, AT&T’s inconsistent behavior could likely produce a return of around 3-4%, which is mostly eaten up by inflation.
As a comparison, the S&P 500’s average return from 1928-2014 is about 10%. So in a best-case scenario with AT&T, you could expect to have similar results as an S&P 500 index fund. But you’d be less diversified and invested in a company that has been inconsistent across various categories.
Considering the more conservative approach, you’d do significantly worse than investing in the S&P 500 index fund.
In my opinion, AT&T is a decent investment for a long-term investor that wants a regular dividend payment. This investor should be the type that doesn’t worry too much about the short-term price swings, and should be a loyal believer in AT&T and its future. While AT&T faces pessimism, share price is down, and the stock is undervalued, this might be viewed as a good time to get in and to offset risk of share price decline with the hefty dividend.
But for me, the choice is certain. I would take an objective look at this company and realize that my money could be better invested in more consistent and profitable investments.
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Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.