Share price of AT&T (T) has dropped by 14.3% from its 52-week high at $39.00 which was reached in April 2013. I believe the current price is close to the bottom level and encourage investors to load up shares based on the following reasons:
AT&T's forward P/E multiple now trades 16.3% below the multiple of S&P 500 Index, and the discount is the deepest compared to its last 12-month trend (see chart below). I believe this relative valuation is compelling for AT&T given that 1) market expects a long-term earnings growth rate of 6.5% for the company, which is not significantly below the average estimate of 8.5% for S&P 500 companies; 2) the stock now offers a 5.5% dividend, which substantially exceeds S&P 500's average at only 1.9%; 3) AT&T has a fairly large buyback program (approximately $16B value of shares was repurchased in a 12-month period up to September 30, 2013); and 4) the company remains the market leader in the US telecom sector despite the competitive pressure.
In addition, the stock's forward EV/EBITDA multiple also trades below the average of AT&T's peers at a notable discount of 24%. Although the below-average valuation can be partially explained by AT&T's weaker growth potential, I believe the discount magnitude remains somewhat exaggerated due to AT&T's above-par profitability condition and the stock's higher dividend yield (see chart below).
I am able to make the same conclusion from a dividend yield perspective. Owing to the price weakness, AT&T's dividend yield has climbed to 1-year high at 5.5%. Below are my observations on the historical dividend-related data:
- Historically, the company has a track record of raising dividend and the quarterly dividend per share has been raised annually by an incremental amount of $0.01 since 2009.
- AT&T has sufficient cash flow capacity to continue boosting the dividend at the current pace. For example, the company generated approximately $15.7 levered free cash flow in a 12-month period as at September 30, 2013, which is more than sufficient to cover its annual dividend spending of about $10B.
- In the past 10 years, AT&T's dividend yield trended at an average of 5.2% and rarely exceeded 6.5%. The only time when the yield surpassed the 6.5% level was during the financial crisis (from 2009 to early 2010) when the stock price was heavily distorted by macro factors (see chart below).
Based on the above, assuming a downside scenario where the stock price continues to drop and causes the dividend yield to rise to 6.5% and AT&T increases the current quarterly dividend from $0.46 to $0.47 per share in early 2014, this case implies a stock price of $28.92 and an 1-year loss of approximately -7% after considering the dividend income throughout the holding period. Street currently has a 1-year price target of $36.96 for the stock. By incorporating the dividend yield, this target would mean a 1-year return of about 16%, implying an odds ratio of more than 2 to 1, which is compelling.
Lastly, there has been a technical price support at $33 since end of 2012, and this may further mitigate the downside risk (see chart below).
While I consider AT&T's further downside is limited by its discounted valuation, I also anticipate that the stock price may benefit from the following developments:
- AT&T introduced "Next" pricing plan in 2013. Management indicated that the new plan has gained notable traction in terms of subscriptions and will likely bring in a positive impact on the company's margin due to reduced subsidy costs.
- Following the acquisition of Leap Wireless (LEAP), it is expected that management will announce its strategy to reposition Leap's Cricket Brand and improve the AT&T's market position in pre-paid market.
- Management does not anticipate there to be a significant change in the current competition landscape for the telecom sector due to industry administrators' firm stance in keeping a 4 major carrier in the market. It is expected that a steady industry development would bring down stock price volatility.
- Further, the company has also been taking initiatives to explore a few long-term opportunities including introduction of corporate sponsored data plans that would drive down costs and improve corporate customer retention as well as partnerships with auto manufacturers (e.g. GM) to develop connected car services.
In summary, I believe AT&T's current discounted valuation has factored in most of the negative developments (e.g. increasing industry competitions) and further downside is likely very limited. Looking forward, I expect the price to rebound owing to a few catalysts as mentioned above. Hence, I believe a buying rating is warranted for the stock.
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 article and the charts is sourced from S&P Capital IQ unless otherwise specified.