Since I first argued how far behind Sprint (S) was to Verizon (VZ) in 4G LTE here, the struggling communications firm lost 30.6% of its value. During the same period, Verizon, not surprisingly appreciated by 6.2%. Based on my multiples analysis and DCF model, I find that Sprint is a "sell", Verizon is roughly trading at fair value, and AT&T (T) is the true value play.
From a multiples perspective, AT&T is the cheapest of the three. It trades at a respective 15.4x and 12.4x past and forward earnings while Verizon trades at a respective 15.7x and 15.4x past and forward earnings. While all of the firms lack volatility, AT&T specifically stands out for its high dividend yield of 5.8%. Given the high interest coverage and management reiteration about returning free cash flow to shareholders, I believe that this dividend yield is sustainable.
Furthermore, at the third quarter earnings call, AT&T's CEO, John Stephens, noted excellent results:
"We are very pleased with what we've accomplished in the third quarter and year-to-date, and we continue to see impressive strength in all our growth engines. Mobile broadband leads the way… Sales were strong across the board, with gains in every subscriber category. Smartphone sales were robust, even in a quarter where you might expect sales to slow. Branded computing devices were also strong, and we turned in impressive service margin results with our best performance in 6 quarters. There also is good news for our Wireline business, where for the first time in 3 years, we posted sequential growth in total and business revenues. IP data continues to be the driver for business and in Wireline Consumer, where we continue to see positive results. The thing I'm most encouraged by is that in addition to solid earnings, we delivered excellent free cash flow".
Free cash flow is now at the highest it has ever been in two years. The company continues to penetrate emerging markets with broadband, in particular, showing its strength. And while the failed effort to acquire Deutsche Telecom's T-Mobile USA (DTEGY.PK) for $39B was disappointing, the stock has still appreciated by nearly 7% since then as the underlying fundamentals remain strong. I anticipate that the impressive results for all key value drivers will carry over into the fourth quarter.
Consensus estimates for AT&T's EPS forecast that it will decline by 2.2% to $2.25 in 2011 and then by 8.4% and 6.6% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $2.39, the rough intrinsic value of the stock is $38.24, implying 26.1% upside. Modeling a CAGR of 4.2% for EPS over the next three years and then discounting backwards at a WACC of 9% yields a fair value figure of $33.48.
While AT&T does not have incredible upside, it certainly dwarfs any risk-adjusted returns Sprint will yield. Sprint continues to pursue a turnaround story, but investors are just not having any of it. Gross subscriber adds may have increased since the second quarter of 2009, but the company is experiencing frightening churn and low expectations for Boost and Virgin. Even the great sales with iPhone come at a cost: namely, margins. And the shift towards smartphones allow for greater fee-based revenues, but there are major competitive pressures from Verizon in this field. Given the uncertainty, I remain bearish on Sprint.
Consensus estimates for Verizon's EPS forecast that it will decline by 3.1% to $2.17 in 2011 and then grow by 16.6% and 13.8% in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $2.48, the stock is trading roughly at fair value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.