As very well explained in Blankenhorn's "How AT&T Became Relevant Again," AT&T (T) continues to effectively leverage its long-lines assets, and to reinvest capital in wireless/cellular/cloud assets, by direct investment and acquisition, as seen in the purchase of DirecTV. At mid-year 2016, with pleasing but not spectacular results, AT&T confirms guidance to meet or exceed expectations for the year.
Over a slightly longer time frame, AT&T continues to be well run: historical returns on sales are about 9.3% (average for the last 10 years), its average asset turnover ratio is about .5 times per year (total assets are about $401 billion), and return on equity continues at about 10% to 11% per year. The dividend has increased by four cents per year over the last seven years, and the current yield is about 4.4%.
The continued investment in wireless/cellular and acquisitions like DirecTV have gradually changed the historic growth pattern in sales revenue. AT&T says it expects to continue low-double digit sales growth, and growth in EPS averaging around 7% per year.
Forecasting sales for AT&T is relatively simple, given the size of its numbers. The forecast is based on a straight line projection of AT&T sales revenue, least squares method. Data are from Morningstar accessed through a proprietary system (a college library) and the AT&T website.
In its presentation of 2Q16 results, AT&T shows 22% year-over-year consolidated revenue growth, due mainly to the DirecTV acquisition. This represents fundamental change. Although it remains to be seen whether these boosts from DirecTV can be sustained, it is clear that some level of fundamental change in growth rates is taking place. The thrust of this article, as well as that of Blankenhorn's work, is that AT&T is showing unexpected agility in its migration to wireless/cellular/cloud and video streaming services across the entertainment/video space, away from the legacy telecommunications utility of the past. Overall revenue for 2015 was up 10.8% over 2014.
Sales figures used for the forecast are the historic 10 years ending in 2015, plus an eleventh year composed of the trailing four quarters ending in June of 2016, as a proxy for 2016. This eleventh year takes into account the apparent fundamental change in revenue growth statistics brought on by the DirecTV acquisition in the second half of 2015, plus the improvement seen in the first and second calendar quarters of 2016, and projects 2016 revenue to be 10.5% greater than 2015. Projected sales revenue forecast here for 2021 is $184.1 billion, reflecting a conservative average compound growth rate past 2016 of only about 3%.
Using the sales forecast of $184.1 billion, 9.3% for return on sales (the 10-year average), and diluted weighted shares outstanding for 2021 of about 5,971 million shares, 2021 diluted GAAP EPS forecast is $3.06. The weighted average shares outstanding number used is the mean value for the 10 years ending in 2015. The actual number varies from year to year, but demonstrates no particular trend toward increasing or decreasing, as shares are bought in stock repurchase programs, shares may be issued in connection with acquisitions, and shares are issued to employees as stock-based compensation.
Stock price forecasts
Utilizing methodology probably first discussed by Graham and espoused by ICLUBcentral, Inc., among others, a range of possible price earnings ratios between 18 and 22 times earnings for AT&T was established by averaging the P/E ratios associated with the annual high stock price over a period of 10 years (the average high P/E) and by averaging the P/E ratios associated with the annual low stock price over the same period (the average low P/E.) These average high and average low P/E ratios give an idea of the treatment accorded by the market when the market is happy with the stock, and when the market is unhappy with the stock. The EPS forecast of $3.06, times the low market average P/E of 18 times earnings establishes the bottom of the expected range of prices for AT&T in 2021 at about $55 per share. The EPS forecast of $3.06 times the high average P/E of 22 expected for 2021 sets the top end of the expected range of AT&T prices in 2021 at about $67 per share.
Although the projection of a top stock price of $67 per share produces the possible 55% upside (and 55% is a big number), the forecast is for stock prices in 2020 and 2021 - five years from today. The compound rate of increase to move to $67 from $43 is only a bit over 8% per year, and the compound rate to move to the low end of the forecast range is only about 5%.
Investing in highly advanced technological companies carries with it significant risk from obsolescence caused by unanticipated technological changes. Such risk could come from within, where a company is unable to adapt as the utility of its products is diminished by advances by competitors, or from without, where the company simply fails to recognize the danger. Kodak (NYSE:KODK) and Blockbuster and AOL (NYSE:AOL) come to mind.
Associated with technological obsolescence is the risk currently being seen in the US, that buying habits of the consumer may change, and the company may respond inadequately. Customers in the US are cutting the cord, i.e., switching to wireless portable technology to deliver video entertainment, and away from cable and cable network delivery. Note that AT&T is responding to this risk with its change in emphasis toward wireless/cellular/cloud and wireless delivery of entertainment.
Investing in extremely large organizations, such as AT&T, also carries some peculiar risks. Statistically, the law of large numbers means it is very difficult to grow an already large firm at a high rate for an extended period, as it takes larger and larger additions to sales revenue to grow the top line at a steady percentage rate, let alone an increasing rate.
AT&T is also subject to all the normal risks faced by all businesses in the US. It has significant debt, and related interest rate risk. It also faces regulatory risks that could change its operating costs, and which could change the cost of its employee benefit plans. General failures in the financial markets could adversely affect the company's ability to raise capital, and affect its ability to continue to grow through acquisitions. There are numerous competitors in its industries, and the competition may prevail to the detriment of the company. Nonetheless, the company seems able to identify, assess, and manage risk competently.
Dividends and returns
AT&T's payout ratio over the last several years has varied, in an apparent effort to maintain a stable dividend with reliable annual increases, but not dependent on the earnings for any particular year. The average annual rate of growth for the dividend over the last five years has been about 2.2%, with the dividend increasing by $.04 per share each of those years. If it continues this practice, the dividend will continue to yield around 3.5% to 4.5%, depending, of course, on the market treatment of the stock. Given a current stock price around $43 per share, the worst case 5-year return expected is a 2021 stock price between $55 and $67, plus a 4% dividend. Roughly speaking, on the low side, this is an average return per year of about 9.5%. On the high side, the dividend yield will be less, but the gain on the stock could be as high as 10% to 11% per year. For the five-year period ending in 2021, the stock could be up as much as 55% from today's $43 per share.
Disclosure: I am/we are long T.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.