AT&T Is A Solid Long-Term Pick

Mar.14.14 | About: AT&T Inc. (T)

Summary

The price wars will eventually affect the margins of the companies in the sector.

Deterioration in margins and revenues due to the price wars can be offset to some extent by increased customer base.

Fundamentals of the company are extremely impressive.

AT&T (NYSE:T) has gained slightly since the start of the month - however, the stock is still down about 8% year-to-date. The trend in the stock price is becoming consistent as the stock has lost about 12% over the last twelve months. As a result, the yield of the stock has surged higher. Companies operating in the mature industries are usually a target of long-term investors as there are fewer chances of sharp movements in the stock price. When we talk about AT&T, we cannot ignore the fact that it is one of the most attractive dividend picks in the sector. So, does the falling stock price make it more attractive for the long-term income investors? I believe so.

Fierce Price Competition

AT&T has been at war with Verizon (NYSE:VZ), T-Mobile and Sprint (NYSE:S) for a long time now. Previously, these companies were competing by offering credit to the new subscribers in order to attract them. The deal between Sprint and T-Mobile can have a considerable impact on the telecom industry. If the proposed merger goes ahead; we might see increased price competition, which will further bring the margins down for these companies. As I have said before, competing on price is the worst strategy in my opinion - the margins become slimmer and the financial health of the company gets a hit. Eventually, the shareholders suffer as the return-on-equity is affected.

Currently, Sprint and T-Mobile are the third and fourth largest wireless services providers. If the merger goes ahead, we will see a stronger competitor for AT&T and Verizon. Sprint and T-Mobile will have a combined market share of about 22%, compared to 27% for AT&T and 31% of Verizon. The CEO of the SoftBank (OTCPK:SFTBF) (owner of Sprint) has already vowed to start a "massive price war" if the deal goes ahead. There is skepticism about the deal due to the regulatory issues and some people believe the deal might not get a go ahead from the authorities - in that interview, SoftBank CEO also addressed that issue and his hint at price war was in fact a signal to the authorities that the deal will be beneficial to the customers.

AT&T Fighting on Price

The telecom industry is characterized by fierce competition and the acquisition efforts by Sprint show how these companies want to consolidate their position in the industry through different measures. The acquisition will give Sprint larger scale of operations and a better platform to compete. To counter the expected competition from its peers, AT&T is focusing on the data services. Customers in the telecom industry usually respond to the price changes; however, these changes need to be significant in order to convince the customers to leave their operator.

Now AT&T has aimed to increase its customer base using the same criteria of attracting customers through decreased prices. The company has slashed its prices by $15 to make it $65 per subscription. The company is banking on acquiring new subscribers as well as some subscribers from its competitors. The rationale behind a price is usually that the increased volumes will make up for the lost revenue through price cuts. However, if the strategy does not work, the business usually lands itself in trouble. As mentioned above, the customers in the telecom industry are moderately price sensitive - meaning the benefit of switching the operator needs to be large enough to convince the customer. However, the most important aspect is the quality of the service. AT&T has the second largest wireless network and I believe the price cut can help it grow its customer base.

Improving Fundamentals

Almost all of the metrics for AT&T's fundamentals look impressive. First of all, the operating margin of the company - AT&T's operating margin currently stands at about 24%, compared to the industry average of 16.6%. Furthermore, the net profit margin of 14.2% for the company is more than double the industry average of 6.3%. The ROA and ROE metrics indicate that the company is using its assets and funds efficiently - again, the ROA and ROE are almost double the industry averages for both these measures. AT&T's ROA of 6.6% beats the industry average of 3.1% while the ROE of 19.9% is almost double the industry average of 10.4%. Moving on to the multiples - the trailing twelve month P/E of the company is 9.5 while the industry's P/E is 19.5. The P/E ratio indicates that the stock is trading at a discount compared to the industry.

Conclusion

As I have mentioned at the start of the article, the stock price movement has been less than impressive for the company. The reason for the poor performance might be the perceived competition in the industry and the pressure on the future margins of the company. As I have stated before, I am not a fan of price wars as I believe this eventually hits the margins of the company. Even if the company is able to achieve a larger market share through the price cuts; it will eventually see deterioration in its margins. However, if we take a look at the fundamentals of the company; it is still an attractive investment. AT&T offers moderate growth in the medium term and an attractive dividend yield (you can read the detailed analysis of the dividend here). It is still a very good investment for the long-term income investors, in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.