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AT&T (NYSE:T) is one of the two telecommunication giants in the U.S. With decent growth opportunities and an attractive dividend yield, the company is extremely popular among income funds and retirement accounts. The company was right on the money as it managed to meet analysts' expectations and reported EPS of $0.64 in 1Q'13. In this article, free cash flow estimates from my previous article will be updated to find out the target price. Moreover, the performance of T in the first quarter of the year will also be discussed.

Key Highlights of Financial Performance of 1Q'13.

EPS experienced a significant rise of 8.5% YoY. Consolidated operating revenues experienced a decline of 1.5% YoY. The Wireless segment performed well due to the rise in revenues, which resulted in an increase of 3.2% YoY in operating income. Not surprisingly, the wireline segment operating income fell around 5%. This decrease was mainly attributed to lower business revenues and higher costs of the Project VIP and U-verse adds. Cash flow paints an encouraging outlook for the firm. The operating cash flows increased around 4.5%, YOY which has added $3.9 billion in free cash flows for the first quarter.

The company is acquiring one of the largest footprints of 4G LTE network. It is expecting to cover 90% of its POPs LTE by the end of this year. T has also improved its subscriber base and churn rate. Total subscribers have reached to 107.3 million and churn has reduced to 1.04%. First quarter U-Verse performance was remarkable as the revenues reached to $2.7 billion, which is an increase of 31.5%. Smartphone sales had increased by $1.2 million in this quarter. A considerable part of T smartphone sales includes iPhone but recently Apple Inc. (NASDAQ:AAPL) seems to be more interested in driving the majority of these sales through its own retail stores.

Valuation

Free cash flow discount model

Assumptions

  • Terminal growth rate is assumed to be 1.25%
  • Public market discount is assumed to be 20%
  • Equity and debt weights are assumed to be 70% and 30% respectively

Calculation of discount rate

Weights

Cost of equity/after tax cost of debt

Discount rate

Equity

0.70

9.25%

6.475

Debt

0.30

3.645%

1.0935

7.5685

2014

2015

2016

Terminal Value

Free cash flows

17.35

18.75

19.75

316.481362

Discount factor

0.9296

0.8642

0.8034

0.8034

Present value

16.1285

16.2037

15.86715

254.261128

Total value of firm (debt +equity)

302.4606

Total debt

70.686

Total value of equity

231.7746

Value of equity after public market discount

185.4197

Total no of shares

5.423

Share Price

34.19

P/E Multiple

Forecasted earnings

Historical P/E multiple

Share price

Bullish case

2.62

14.1

36.94

Bearish case

2.44

14.1

34.40

Average Price=35.67

The stock is currently trading at $35.88 per share, which shows that according to the discounted cash flow analysis T is slightly overvalued. I believe that the company has a limited potential for multiple expansion.

Risks

The company has held a decent share of the U.S. telecom markets with Verizon Communications, Inc. (NYSE:VZ) for many years. But now Sprint Nextel (NYSE:S) after the completion of its deal with SoftBank and Clearwire Corp. (CLWR) is becoming a serious threat to the market leaders. The company's prime competition, VZ is also planning to enter the Canadian markets, which will enhance its growth opportunities along with its cost savings in terms of lower roaming charges. Finally, additional spending by consumers is primarily linked with the economic conditions.

Conclusion

Companies

Net debt/ adjusted EBITDA

P/S

Next 5 yr growth rate per annum

Dividend yield

PEG ratio (5 yr expected)

AT&T, Inc.

1.68x

1.49x

6.28%

5.00%

2.28

VZ

1.2x

1.22x

10.48%

4.00%

1.75

Source: Yahoo Finance

The above table is not showing encouraging results for the company. However, the company has an attractive dividend yield in the current low-yield environment. Moreover, the company has free cash flow strength to grow its dividends as it has done in the past. The company owns its wireless business completely whereas its major competitor VZ only owns a 55% share of its wireless segment. I believe that T has limited growth opportunity but it will continue to strike for dividend seekers.

Source: AT&T: High Dividend Yield With Limited Growth Opportunity