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Summary

  • This article focuses on the strengths and weaknesses of AT&T.
  • Specifically, we look at the company’s profitability, income potential, balance sheet risk and valuation.
  • We also compare it to a sub industry peer and find that AT&T could be a bargain right now.

In this article we are focusing on AT&T (NYSE:T) and concentrating on its positive and negative attributes. We're also comparing it to CenturyLink (NYSE:CTL) since the two companies sit in the same GICS sector of telecommunications services, as well as the same GICS sub industry of integrated telecommunications services. We realize that the two companies are of very different sizes, with AT&T having a market cap of $179 billion and CenturyLink's market cap being just $22 billion. However, we think the comparison could prove useful as many investors apportion capital based on GICS sectors and GICS sub industries and we're also interested to see how AT&T matches up against a smaller and potentially more nimble rival, too.

Profitability

We're impressed with AT&T's levels of profitability in its most recent full-year results. Indeed, the company was able to post relatively high numbers for return on equity and return on assets despite having only moderate levels of financial gearing. For example, return on equity was 20.4% last year, which highlights just how much bang for their buck equity holders are receiving, while AT&T's debt to equity ratio was just 91%. This shows that the company is not carrying too much balance sheet risk and is not overly-exposed to interest rate risk, either. It also means that the return on equity figure is not being falsely inflated through a capital structure that places undue risk on the company. In addition, a return on assets figure of 6.7% is also attractive and highlights how efficiently AT&T is using its large asset base to generate profits for shareholders.

A Top Income Play

Meanwhile, AT&T also delivers in terms of income. Shares in the company currently yield a highly impressive 5.9%, which is nearly three times the S&P 500's yield of just under 2% and shows that AT&T is likely to be a core holding for many income investors out there. Furthermore, we feel that there is significant potential for AT&T's yield to go much higher, since the company pays out just 53% of profits as a dividend each year. Sure, AT&T needs to retain some cash to grow the business, but for a mature company in a mature industry, we think that the payout ratio could be increased to offer investors an even more generous return.

Growth Potential

Although AT&T's earnings are only forecast to grow by 3.8% next year, the company's earnings numbers continue to look relatively attractive when compared to sub industry peers such as CenturyLink. It made a loss last year, although it is forecast to return to profitability this year. However, it is not set to be a return to profit growth, since its earnings are due to fall by 2.7% next year, which is disappointing. Indeed, this fact highlights that the industry is going through a tough period, with margins being squeezed and demand being volatile, which makes AT&T's earnings numbers and growth profile all the more impressive.

Valuation

Despite its strong profitability and relatively impressive earnings profile, AT&T still looks good value in our opinion. For instance, while the S&P 500 trades on a forward P/E of 16.2, AT&T's forward P/E is just 12.7. Moreover, CenturyLink's forward P/E is 15.4, which provides further evidence that AT&T could be undervalued. In addition, AT&T's EV/EBITDA ratio is low at 5.47, which represents a discount of 8.4% to CenturyLink's 5.97, while its price to book ratio of 1.98 appears to be very reasonable when the high levels of profitability are taken into account. As a result, we think that AT&T could outperform its sub industry peer, CenturyLink, going forward.

Conclusion

AT&T appears to be performing well. Its profitability is strong on both an absolute and relative basis, with it posting return on equity and return on asset numbers of 20.4% and 6.7% last year. This compares favorably to sub industry peer, CenturyLink, which made a loss last year and is set to see earnings fall next year once they have rebounded into the black this year. Furthermore, AT&T offers a superb yield of 5.9%, which we think has the potential to grow due to a moderate payout ratio. In addition, the forward P/E ratio and EV/EBITDA ratio, as well as the price to book ratio, appear to indicate good value versus sub industry peer, CenturyLink. As a result, we believe that AT&T could outperform CenturyLink going forward, as the market reacts to what appears to be a mispricing and bids up the share price of AT&T to correct this.

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Source: Why AT&T Looks Like A Bargain