AT&T (T) is one of the largest telecommunications companies in the world. The company is the market leader for mobile phone services in the US and offers broadband and fixed wire connections. AT&T went through a series of acquisitions over the past several years to become a large content provider. However, total debt and leverage arguably rose too high. The current CEO is changing the strategy, and AT&T (T) is returning to its roots and focusing on telecommunications. AT&T is divesting most of its content business, including the Latin American businesses, DirecTV, and WarnerMedia. This divestment will refocus the company and reduce total debt with revenue and earnings per share growth in the low-to-mid single-digits. One negative, though, is that AT&T’s dividend will be cut. The new dividend yield will be lower, but dividend safety will improve. AT&T is not a favorite of investors right now. The stock price is down about (-16%) year-to-date, and the valuation multiple has fallen. I view the stock as a buy despite the dividend cut due to the low valuation.

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Overview Of AT&T

AT&T is the world’s largest telecommunication company by revenue. The company operates in three business segments: AT&T Communications, WarnerMedia, and AT&T Latin America. AT&T Communications is the largest business and includes Mobility (wireless), Consumer Wireline, and Business Wireline. AT&T has about 100 million US consumers, 3 million business customers, 17 million TV customers, and 15 million fiber broadband customers. Total revenue was $171.8 billion in 2020 and $173.6 billion in the LTM.

Selected Data For AT&T (NYSE)

Source: Data from Seeking Alpha (as of November 22, 2021)

AT&T’s Dividend And Dividend Safety

Before the acquisition of WarnerMedia and the impending reorganization, AT&T was a dividend growth stock. The company had previously raised the dividend for 36 years in a row, making the stock a Dividend Aristocrat. However, the dividend has been held constant for the past eight quarters breaking the streak of increases. In addition, the transaction to acquire WarnerMedia was completed in June 2018, so the dividend freeze coincides with the acquisition.

AT&T’s annual dividend rate is currently $2.08 per share. The stock price has declined since May 2021, and simultaneously the dividend yield has risen to roughly 8.6%, as seen in the chart from Portfolio Insight*. This yield seems attractive, but AT&T’s dividend will be cut due to the reorganization. Based on free cash flow, the dividend cut will reduce the dividend rate to about 40% to 43% of the expected free cash flow (FCF) of $20 billion. This cut means that the dividend will consume about $8 to $8.6 billion of free cash flow. It is important to know that the current dividend requires about $15 billion in FCF. Therefore, we estimate that the dividend will be roughly half of the current rate at $1.04 per share, resulting in a dividend yield of about 4.3% at the current stock price. In relative terms, the dividend is a good one but much lower than before the divestment.

(Click on image to enlarge)

Image Source: Portfolio Insight*

In addition, AT&T’s dividend safety will be much improved in the context of free cash flow. The current payout ratio is approximately 62%, and the future payout ratio is unknown. However, the payout ratio will likely be lower than before the reorganization.

Since the merger with Time Warner, AT&T has focused on reducing debt. The dividend has been held constant in part to reduce debt. Furthermore, AT&T will reduce net debt by ~$43 billion by spinning off WarnerMedia. Net debt at the end of Q3 2021 was $188,201 billion. AT&T will still be indebted after the spinoff, but debt should not place the reduced dividend rate at risk. AT&T’s credit ratings are Baa2 from Moody’s, BBB from S&P Global, and BBB+ from Fitch. These are all investment-grade ratings.

Competitive Advantage, Risks And Valuation for AT&T

Competitive Advantages

AT&T’s competitive advantage is its strong brand name and scale. Almost every consumer and business in the US knows AT&T. The company is the market leader in wireless, and most large businesses are customers of AT&T. The wireless business is the largest and arguably most important one. The company is in an oligopoly with Verizon (VZ) and T-Mobile (TMUS), and together they control about 90%+ of the US market. The wireline business is also essential, and AT&T has about 55 million connections. AT&T is in the process of converting these to fiber.

Risks

The main risk for AT&T is poor capital allocation. The company has repeatedly demonstrated an inability to correctly assess acquisitions resulting in value destruction for shareholders. For example, DirecTV was acquired for about $67 billion in 2015. Since AT&T bought the company, DirecTV has continuously lost customers. The spinoff value was about $16.25 billion, meaning that AT&T received less than it paid for DirecTV. Similarly, AT&T’s ill-fated acquisition of WarnerMedia is now being undone after only three years.

The other significant risk to AT&T is competition. Both the wireless and fiber businesses have strong competitors with deep pockets. AT&T is an important player, but it has no distinct advantage. Competitors include Verizon and T-Mobile in wireless, Verizon, Comcast (CMCSA), and other cable providers in fiber and broadband.

Valuation

AT&T’s stock price has been in a downtrend since May 2021. The stock is in bear market territory, down more than a third from its 52-week high of $33.88. AT&T’s stock price is $24.70 as of this writing. The stock chart from Stock Rover* shows that the stock price is below the 50-day and 200-day moving averages.

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Image Source:  Stock Rover*

From a price-to-earnings (P/E) ratio multiple, AT&T is undervalued. The forward P/E ratio is 7.7X. AT&T has historically traded at a P/E ratio of about 12X in the past decade. If we discount the P/E to 10X for a fair value estimate, we get $33 per share based on consensus earnings of $3.38 per share. 

A discounted cash flow (DCF) analysis utilizing finbox and a discount rate of 7%, revenue growth of (-0.1%), and unlevered FCF of (-0.1%) gives a fair value of $38.66. In addition, comparison to peers using finbox for EV-to-revenue provides a fair value of $31.35, and for EV-to-EBITDA offers a fair value of $31.42.

Final Thoughts On AT&T Focusing On Telecommunications

AT&T is a company in transition. However, once the transformation is complete, AT&T will be focusing on telecommunications, namely wireless and fiber. These are mature businesses, but AT&T should grow revenue and earnings in the low-to-mid single-digit range. As a result, AT&T will be more like its main competitor Verison. However, in comparing AT&T vs Verizon, Verizon is growing faster and has a more focused strategy arguably making it a better dividend growth stock. It is possible that after the spinoff of WarnerMedia, AT&T’s dividend will grow again since net debt will be lower, and the dividend safety metrics will be much improved. In addition, the stock is undervalued. However, investors should be aware of the risks before buying AT&T.