Back on December 12, 2012, I published an article entitled "Buy Shares of AT&T." Well, those of you that did made money; the share price of AT&T (T) increased substantially since the bullish call back in December. Now it is time to revisit the valuations and financial performance of the firm to see what is our next move.
Investors need to know what they should do with their shares of AT&T. Thus, I will attempt to forecast the share price. My focus is on improving risk-adjusted returns or generating alpha.
We'll use the historic financial performance, including the operating segment performance, to determine where AT&T came from to reach where it is today. Then, we'll forecast AT&T's financial performance in 2013. Also, we'll create a forward multiplier model valuation. The technical perspective will be incorporated into the analysis. Finally, we'll finish with the conclusion and recommendations for further research.
The valuations are getting a bit extended; investors should reduce long-equity exposure to shares of AT&T. Next, we'll cover the historic financial performance.
Consolidated Historic Financial Performance
We are going to assess the historic financial performance of AT&T. We'll use the consolidated revenue, consolidated operating income, and consolidated net income. We'll discuss some of the growth rates and margins. Additionally, analysis of the dividend, EPS, and retention rate will be included.
Between 2002 and 2012, AT&T's revenue grew at a compound annual rate of 11.5 percent. Revenue hasn't grown much recently: In 2012, revenue increased 0.6 percent, and in 2011, revenue grew 2 percent. Revenue in 2012 was $127.4 billion. Operating income increased 41 percent in 2012 compared to 2011 but remains well below the 2007 peak of $29 billion. Operating income in 2012 was almost $13 billion. The operating margin was below the 2002 to 2012 average of 15 percent in 2012; the operating margin in 2012 was 10 percent. That follows an operating margin of 7 percent in 2011. Net income of $7.5 billion, in 2012, was below the 2010 peak of $20.1 billion. The net income margin, in 2012 was below the 2002 to 2012 average of 10 percent; the net income margin in 2012 was 6 percent.
AT&T has a long history of dividend increases; the firm increased the dividend in 2012 to $1.77. The pace of dividend increase slowed in recent years as net income growth slowed. Between 2008 and 2012, AT&T had a low or negative retention rate. In other words, the firm paid more in dividends to shareholders than it earned.
The financial performance reflects the fact that the firm operates in an industry that is regulated. Typically, utilities aren't growth firms. That said, some non-cash charges distort the operating income and net income of the firm. Overall, I would say that the financial performance of the firm is bullish for the common equity share price.
Some people may not make the adjustments to the non-cash expenses. Also, growth investors may be looking for a company with a higher current growth rate. Also, cautious dividend or value investors may prefer companies with higher retention rates.
That said, AT&T's financial performance is bullish for common equity shares of the firm. Next, we'll discuss the operating segment performance.
Operating Segment Performance
The wireline segment revenue and segment income, and wireless segment revenue and segment income will be included in this section. We'll discuss the historic performance over the past few years. The wireline business segment is facing challenges.
The wireless operating segment revenue increased 8 percent in 2011 and 6 percent in 2012; wireless segment income decreased 2 percent in 2011 and 6 percent in 2012; the margin declined from 27 percent in 2010 to 25 percent in 2012. Wireline segment revenue declined 3 percent in 2011 and 1 percent in 2012; wireline segment income declined 5 percent in 2011 and increased 1 percent in 2012.
The wireline segment is composed of data revenue, voice revenue and other revenue. In 2010 and 2011, data revenue grew in the high single digits while voice revenue declined by roughly 10 percent both years. Other revenue declined 8 percent in 2011 and 6 percent in 2012.
I anticipate that we will continue to see growth from the wireless segment and contraction in the wireline segment. I'm not sure management can do much to stem the decline in voice revenue, but management may be able to increase other revenue or grow data revenue faster. Some customers are transitioning from voice to data.
Overall, I would say that the operating segment performance is bullish for the common equity share price of AT&T. The key business groups, wireless and data, continue to increase revenue. Next, we'll discuss my 2013 forecast.
In this section, we'll discuss my forecast for 2013. Forecasting is an essential part of equity analysis. The forecast will be used later in this paper when we value the common equity shares. Also, a forecast sets the baseline to compare actual versus estimated performance.
In 2013, I am forecasting revenue in the $127 billion to $128 billion range. Operating income should be in the $10 billion to $20 billion, and average shares outstanding should be roughly 5.5 billion. Operating income will be closer to $20 billion if fourth quarter operating income is positive.
I'm forecasting revenue that is roughly flat compared to 2012. Also, the average basic shares outstanding should continue to decline. That said, first quarter revenue should be in the $31.7 billion to $32 billion range; operating income should be between $6 billion and $6.5 billion.
Thus, I'm not forecasting any major changes for AT&T in 2013. Next, we'll use the forecast to create forward multiplier model valuations.
In this section, we'll create forward multiplier model valuations. We'll create a forward price-sales and price-operating income valuation. Valuation is an essential part of equity analysis. We'll use the valuation to reach an investment recommendation.
The current share price used for the forward valuations is $33.60. Using forecasted average basic shares outstanding of 5.5 billion and my revenue forecast, the forward price-sales ratio is between 1.46 and 1.44. The current price-sales ratio is 1.49. My forward price-operating income ratio is between 18.48 and 9.24. The time-series valuations have increased substantially recently.
While the absolute level of the valuations aren't excessively high, the time-series relative valuation may be near a peak. Additionally, the price-sales ratio historically has peaked in the 1.50 to 2.00 range. Thus, I would say that common equity shares of AT&T are intermediate-term overvalued. Next, we'll discuss what the charts are telling us.
Technical analysis is used to manage practical risk. Trend analysis is at the heart of technical analysis. We'll use some trend indicators and momentum indicators. Also, I'll include Dow theory analysis. Finally, we'll reach a conclusion based on what the technicals are telling us.
The share price of AT&T continues to make higher minor highs and higher minor lows. The share price is above the rising 50-day simple moving average. The momentum indicators are confirming the up-trend. However, we are at a previous resistance zone and the long-term indicators are suggesting latent weakness. That said, we remain in a Dow theory bull market and any weakness in the share price should only be intermediate term in nature.
The technicals are telling us that while the market for shares of AT&T remains in a short-term bull market, investors would be wise to reduce long-equity exposure. Next, we'll cover my investment recommendation.
While the financial performance is solid, the time-series relative valuations and technicals are telling us to reduce long-equity exposure to shares of AT&T. Thus, investors would be wise to heed the warning. Professional investors seeking superior risk-adjusted returns should increase long-equity exposure during an intermediate-term decline. Long-term or buy-and-hold investors should continue to hold their shares. Short-term traders should still be buying dips, and intermediate-term traders should be preparing to get short.
Additional research should include some geographic data, if available, and information about management's strategies.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.