AT&T: Do Not Let The Yield Fool You

Summary

• While the dividend yield is tempting, be cautious and do not let it fool you.
• Huge debt load means shareholder returns are limited.
• I give T a true value of $40.72 which implies 36% upside.

Investment Thesis

AT&T Inc. (T) is not as attractive as other potential income investments out there. Especially for income investors, there are better options with less risk elsewhere.

Company Background

Source: Bing Images

As the first truly modern media company, AT&T has been changing the way people live, work and play for the past 144 years. It started with Alexander Graham Bell's telephone. Since then, our legacy of innovation sparked the invention of the transistor - the building block of today's digital world - as well as the solar cell, the communications satellite and machine learning. Throughout its history, AT&T has reinvented itself time and time again. Most recently, the company added WarnerMedia to reshape the world of technology, media and telecommunications. And the two companies are no strangers to making history together. In the 1920s, AT&T built technology to add sound to motion pictures which Warner Bros. then used to create the first talking picture, The Jazz Singer. For over 100 years, WarnerMedia and its family of companies have redefined how audiences around the world consume media and entertainment. It launched the first premium network in HBO and introduced the world's first 24-hour all-news network in CNN. WarnerMedia continues to deliver popular content to global audiences from a diverse array of talented storytellers and journalists. Today, we're shaping the future with premium content, high-speed networks, direct-to-consumer relationships and an advanced ad technology platform. AT&T and its employees are united by a shared desire to inspire progress and change the world for the better.

Source: AT&T Corporate Profile

The company is in a very competitive space that includes but not limited to: (VZ), (TMUS), (CMCSA), and even (NFLX). All of which compete heavily for customers in the communications services sector.

As for T's fundamentals, the company is solid with some aspects that could be better. Seeking Alpha gives T a value rating of B-, profitability rating of A+, a growth grade of D, and a dividend scorecard average of 7.25 which falls under the "Good" range. The company has a dividend growth streak of 35 years giving it the Aristocrat title and a current payout ratio of 64%. According to Seeking Alpha, the dividend is stable, but it does not come with much margin of safety. T's 10-year CAGR is a disappointing 2.21%. I consider this CAGR to be extremely low considering I always assume inflation to come in at 2.5%.

As for the pandemic and its effects on T, the company pulled their guidance after their last earnings report which showed each of their segments being hit. The pandemic cost the company roughly $600M according to management. This came as a surprise to me. I would have assumed that the company would have seen an increase in segment revenues and profits due to more people working from home leading to an increase in demand for their services. The earnings during the heat of the pandemic were below expectations relative to pre-pandemic estimates. Now that the economy is opening back up and we do not know how good or bad the company would do for a prolonged economic shutdown, I think it is safe to say the earnings were respectable.

As for the company's debt, it is not the nicest to look at. As with most companies, debt usually is not a good thing to have. In T's case, they have a lot of it. According to Seeking Alpha, they have a whopping $189.61B in debt. That is a big load compared to its peers like Verizon at $133.63B, Comcast at $100.23B, Netflix at $11.11B, and T Mobile at $43.21B. Do not worry, I will get back to the debt later in the article.

Valuations

Price to Earnings (P/E): This method puts a value to a company relative to its historical P/E ratio. To do this, let us take a look at the current P/E and compare it to the five-year average P/E. At the time of writing, T is trading at $29.87. This implies a current P/E of 15.18 using its TTM earnings of $1.97. The 5-year average P/E is 16.44. Based on this, I calculated the stock to be valued at $32.39.

T's forward P/E is 12.60. This implies earnings of $2.37. The 5-year average forward P/E is 14.21. Based on this, I calculated the stock to be valued at $33.68.

Dividend Yield (NYSE:DY): This method uses its current dividend yield and compares it to its historical average dividend yield. Then, with its current annual dividend payment, determines what the value would be if the stock reverted to its five-year average dividend yield. At the current price of $29.87, the stock has a dividend yield of 6.96%. The stock has a 5-year average dividend yield of 5.49%. If the company were to return to its 5-year average yield on its current dividend payment of $2.08, the stock would be valued at $37.89.

Discounted Cash Flow Model (NYSE:DCF): This model takes into account the stock's estimated growth. Based on a 15 year model, I used a discount rate of 9% to match the rough average return of the stock market, a terminal growth rate of 2.5% for 5 years to match a high inflation estimate, a growth rate of 5% for 10 years which is double the 10-year CAGR, and TTM earnings of $1.97. Based on this, I calculated the stock to be valued at $21.79.

This method is the most complicated of all the valuation methods used since it involves a lot of assumptions to come up with a value. I tried to mimic the stock's history to simulate the best value I could come up with. The value I generated comes with a margin of safety of -37%.

I did the same calculations except I changed the earnings to their projected forward earnings of $2.37. Based on this change, I calculated the stock to be valued at $26.21.

The value I generated comes with a margin of safety of -14%. Although I tried my best to mimic the stocks history, both DCF values came with horrible margins of safety.

Enterprise Value (NYSE:EV): This method takes into account a company's short-term and long-term debt, market cap, and any cash on hand and assets. According to this, I calculated the stock to be valued at $58.93.

Averaging out all the valuations and according to my calculations, T is valued at $35.14. However, this value took into account both DCF values which had ridiculously low margins of safety. So, to get a more accurate value, I will remove these inaccurate valuations from my analysis.

Averaging out all the valuations without the DCF values, the new stock value is $40.72. In either case, I would put more emphasis on the dividend yield calculation since this is probably the most accurate value of the stock given the company's dividend history.

Risks Associated With T

The main risk and the only risk I see is the company's debt load. See, I told you I would get back to it.

Like I mentioned earlier, T has a whopping $189.61B in debt. Debt can be good in some cases and it can be bad in others. I think in the case of T, it is pretty bad. For an established company like this to hold such huge amounts of debt and not put any real emphasis on paying it down, it limits shareholder returns drastically. If T were to put even a little bit more energy into reducing debt rather than waiting till payments are due, shareholders could see huge returns in the long-term. For instance, in Kevin Mackie's article If AT&T Cuts Its Dividend, I'm A Buyer, he goes into a great deal on what the possibilities are for shareholders if T suspended its dividend and solely focused on paying off its debt. I was shocked by the potential returns.

For now, T can comfortably continue funding its dividend and continue giving shareholders returns that might or might not beat inflation according to its 10-year CAGR. However, the debt is holding potential returns back and should be a sign to move on to better things. Their debt has and will be eating away at their cash year after year limiting the potential dividend increases, share buybacks, and company growth. All of which should worry every investor. Because of this, I will not be surprised if T keeps pushing out these measly 2% dividend increases and maintains high levels of debt.

All in all, T is limiting itself and its shareholders by maintaining such high debt levels.

Conclusion

For the reasons I mentioned above, I believe T is currently undervalued according to its historical dividend yield and other valuation metrics. However, I also believe there are far better opportunities out there today. If you like a company limited by debt and wish to take your chances, then T might be right for you. If not, and you want to have your money work harder for you, I would suggest looking elsewhere.

Based on a value and dividend growth perspective, I think the stock is not as attractive as other investments out there. There are plenty other stocks with high yields and a lot less worry attached to them. Because of this, I have been looking for alternatives to T that I can get at a discount. I currently hold T in my divgro portfolio, but I have not added to my position. I have let it build up with my DRIP plan waiting for the right moment to move on to a better alternative.

Be careful when choosing investments to add to your portfolio during the current market climate since valuations are skewed and fundamentals have been shaken. Do your own research before making any decisions with your money.

I hope you enjoyed the brief analysis of T, and if you want to read more analysis type articles then give me a follow and let me know in the comments what stocks you would like me to analyze.

Disclosure: I am/we are long T. 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.

Additional disclosure: I am not a financial advisor and do not claim to be one. I am only providing my own insights into a stock and should be taken with caution. Do your own research before making any decisions.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.