Weekly Stock Call

July 29, 2010
Current Price – US$26.04


While AT&T Inc. is basically a utility there are two factors that make it a compelling investment candidate at this time. First, the stock is paying a dividend that yields 6.5% and is trading at low valuation relative to historic pricing ratios and discounted value of projected cash flows. The dividend has increased annually for past 26 years and appears to be secure given that the company continues to generate more than sufficient operating cash flow to support growth, pay dividends and cover interest many times over. Second, AT&T appears to be well positioned to benefit from trends toward increased usage in mobile broadband, wireline data services and convergence of communications/entertainment services. The company has made capital investments of more than $55B to support growth in these areas in the past three years has the advantage of being the exclusive U.S. carrier of iPhones, giving it an early lead in capture of broadband mobile market share. Rumors circulate that the exclusive relationship with Apple might not continue much longer, but in the meantime, AT&T continues to capitalize on the love affair with all-things-Apple. The transition from voice services to higher margin broadband services (both wireline and wireless) that the industry is currently undergoing offers the opportunity to see a bump in share prices that would be uncharacteristic for a mature telephone utility. At current valuations, this growth does not seem to be fully priced into AT&T’s shares.

AT&T Inc. (T) is a communications holding company who, through its subsidiaries and affiliates, provides wireless, Wi-Fi, high speed Internet and voice services. The company has annual consolidated revenues of US$123B derived from four primary business segments: Wireless (45% of revenues), Wireline Voice (25%), Wireline Data and Managed Services (25%) and Advertising Solutions and Other (5%). 


Valuation

Based on a blend of valuation methods (discounted cash flows, dividend discount model and, historical and industry price ratios) I arrive at a current valuation for AT&T Inc.of US$28.94.

Expected return should this price be realized in the markets within the next 12 months would be:

Price yield         11.2%
Dividend yield     6.5%
Total return       17.7%


Risks

Listed below are some of the immediate risks faced by the company. For a more complete discussion of risk, refer to the company’s annual report.

General Economic Conditions – a return to recessionary conditions or a prolonged recovery could lead to reduced discretionary spending by consumers or financial difficulties for key suppliers of network equipment.

Regulation – asymmetrical regulation of the converging industries in which AT&T operates may result in AT&T being unable to compete on level playing field in some instances and modification to existing regulations may remove some of AT&T’s established advantages in others.

Competition – high margins in growing business segments invite competition from new companies that are subject to lower historical cost basis and may be subject to lesser regulatory conditions. Increased competition would tend to increase pricing pressures and drive down profit margins.

Spectrum Availability – restrictions on general and company specific access to required radio spectrum may inhibit revenue growth.


The Numbers

Share Price ($US)   26.04 
Market Cap ($US B)   154 
No. Shares (M)   5,926 
ROE   12.7%
ROA   4.8%
P/E Ratio   13.1 
Price/Sales Ratio   1.5 
Price/Book   1.3 
Current Ratio   0.6 
Interest Coverage   5.2 
Total Debt/Equity   0.67

Analyst – David Scollon


Disclosure - At publication of this analysis I hold no position in this security, but may take a long position in the future. I do not take short positions in any of the stocks reviewed on this site, nor do I receive any compensation from the companies studied for publication of my opinions.


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