AT&T (NYSE:T) has existed in some form or another for more than 100 years, which gives the company a rich heritage and solid reputation to trade on.
However, like the majority of its peers in the telecoms sector around the world, AT&T is coming under pressure from increasing competition, slowing consumer spending and rising costs, all of which are pressuring the company's revenues, profits and shareholder returns.
Growth is slowing
Growth is slowing for AT&T. Both the company's revenues and profits are stagnating and even falling despite an increasing number of consumers using cell phones and internet connections throughout the world.
Since 2008, AT&T's revenues have grown 2.7%, which is a compounded annual growth rate of a mere 0.7%. Meanwhile, the company's net income has fallen a staggering 43% during the same period, a CAGR of -13%.
The reason behind the company's falling net income is rapidly rising costs, which have squeezed AT&T's margins. During 2008, the company's gross profit margin was 44%, this has now fallen marginally to 42%. However, AT&T's net margin has collapsed from 10% during 2008, to 5.7% in 2012.
Question is, will this trend continue?
Once dominant in the telecom industry, AT&T is now facing increasing competition from every angle. The most recent threat is from Google Fiber (NASDAQ:GOOG).
Currently in its infancy, Fiber has the ability to seriously impact not just AT&T's income, but the telecoms industry as a whole. Fiber has been designed with modern day, high-speed internet connectivity in-mind, while the older network providers are still struggling to upgrade creaking copper networks.
While Fiber is currently a minor threat, there is increasing merger activity within the U.S. telecoms market. After failing to merge with AT&T, Deutsche Telekom AG expanded its wireless presence within the U.S. by merging its mobile network, T-Mobile with MetroPCS Communications (NASDAQ:TMUS), merging the fourth and fifth largest wireless carries within the U.S., forming what could now be a serious threat to AT&T and Verizon (NYSE:VZ).
In addition, it appears that AT&T is also spending less than its peers to stay ahead of the game. During 2011 and 2012, AT&T spent roughly $19.5 billion a year updating and upgrading its network and expanding via capital expenditure spending. However, during the same period, Verizon, which has significantly lower revenues and a smaller market capitalization, spent $19 billion in 2011 and more than $20 billion in 2012.
In percentage terms, Verizon is spending 67% of net income on expanding, while AT&T is spending around 48%, forgoing capital expenditure while increasing shareholder returns and paying down debt.
What about the dividend?
Of course, AT&T offers shareholders a respectable dividend yield, currently just under 5% almost double the market average of 2%. Many financial websites will quote that the dividend is not covered from earnings per share, however, this is not the case.
You see, AT&T issues its dividend from free cash flow, which is not the same as earnings per share, as free cash flow excludes factors such as depreciation and amortization. On this basis, AT&T's dividend is well covered.
For example, during 2012 the company had a net operating cash flow of $38.9 billion, CapEx spending and investing activities cost the company $19.4 billion, which left $19.5 billion for shareholders. Of this, AT&T paid out $10.2 billion in dividends and repurchased $12.3 billion in stock (AT&T had to borrow an additional $4.8 billion to balance the books).
AT&T has maintained a strong dividend payout for many years, consistently paying and raising its dividend for 28 years, giving investors' confidence in its payout.
The company appears to be undervalued
Meanwhile, the company appears to be undervalued versus its closest competitor Verizon. Indeed, AT&T is trading on a trailing price to earnings ratio of 29, while Verizon is trading at 133 trailing earnings. Additionally, on a forward basis, AT&T is trading at 13.9 forward earnings, while Verizon trades at 16.6 times. AT&T also offers a larger dividend, of 4.8% compared to Verizon's 3.9%.
So overall, growth is slow at AT&T and the company is being pressured by its peers. However, the company offers a solid, well-covered, dividend and currently trades at a discount to other major mobile telecom.
Having said that, the company could be heading for trouble in the not-too-distant-future as its CapEx spending lags behind the rest of the industry and consumers start to notice this, moving to faster and more up-to-date peers.
So, while AT&T is returning lots of cash to shareholders, future growth prospects remain slim. For income, AT&T is a good choice but for growth, investors should look elsewhere in the sector.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.