The share price of AT&T (T) has appreciated by 14% year to date and just made its 52-week high at $38.80. Despite AT&T's healthy fundamentals and the stock's decent 4.7% dividend yield, it is difficult to justify the current share price based on the following 5 reasons:
1. The shares are somewhat expensive based on the company's financial performance relative to Verizon Communications (VZ). According to the chart shown below, AT&T generally underperforms Verizon in terms of growth and profitability. On the leverage and liquidity side, AT&T carries a higher debt load. However, the company has a higher free cash flow margin. Both companies' current and quick ratios are fairly comparable.
Despite all that, AT&T's forward EBITDA multiple is almost 10% above that of Verizon. Although the stock's forward P/E multiple is trading at a discount to Verizon's, after accounting for the 5-year EPS growth estimate, the stock's PEG ratio of 2.5x is even 21% above Verizon's PEG, suggesting an overvaluation on a relative basis (see chart above).
2. In 2013, AT&T has experienced not significant corporate improvement, and this is reflected by the firm's stable trend of its consensus revenue, EBITDA, and EPS estimates for 2013 and 2014. In addition, analysts' average long-term earnings growth estimate has even been lowered slightly from 6.2% to 6.0% since 3 months ago (see charts below).
Nevertheless, the stock's EV/EBITDA, P/E, and PEG multiples have expanded by 7.7%, 8.1%, and 12.3%, respectively, year to date, implying that the elevated valuation has become increasingly frothy (see charts below).
3. According to Thomson One, analysts' average 1-year price target of $36.80 is 4.6% below the current share price at $38.59. Given the cost of equity for AT&T should be above 5.0%, sell side is implying that the stock is overvalued by 10%.
4. After the significant price appreciation, the stock's dividend yield is approaching its 3-year low. Given the 5.7% average 3-year dividend yield, the institutional income investors may not find the stock as attractive as before and hence the strength of the dividend downside support would diminish (see chart below).
5. In the recent announcement of a new share repurchase program, AT&T reiterated that the company will strive to maintain its single A credit rating and as such the firm is going to buy back shares opportunistically. In a research note dated April 1, Brett Feldman at Deutsche Bank commented on his concern about the buyback issue which I tend to agree on (sourced from Thomson One, Equity Research):
"In our view, a slowdown could put technical pressure on the stock as our analysis indicates that repurchases have driven a meaningful amount of trading volume over the last two quarters. For example, based on T's disclosures, we estimate share repurchases represented 11% of total trading volume in 1Q13, up from nearly 8% in 4Q12. However, despite this contribution to demand for the stock, T underperformed the S&P 500 by 120 bp in 1Q13 and 960 bp in 4Q12. We believe the reason T expects its repurchase activity to slow is that it has utilized most of its free liquidity. For example, including just the current buyback, T has committed to $22B of share repurchases, dividends and acquisitions of spectrum and other assets this year against estimated FCF of $14.5B."
Given that issue, however, I do not see it being priced in as the share price has climbed by 5% month to date.
Bottom line, the recent price run-up has caused AT&T's valuation to modestly deviate from its fundamentals. While shareholders should continue to hold given the 4.7% dividend yield, buyers should wait for a pullback from a margin of safety perspective.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the charts and the article is sourced from S&P Capital IQ unless otherwise specified.