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AT&T (T) is a provider of telecommunication services in the US and several companies around the world. It has a market capitalization of $181 billion and has a debt to equity ratio of 61%. The stock has lagged the S&P 500 index during the last 1 year by returning 1% to the shareholders compared to the 6% return of the index. The stock pays a dividend yield of 5.8%. In this article, we will examine the company's fundamentals and perform a valuation analysis to determine if the stock is cheap at current levels.

Growth:

The company posted a 3 year annualized growth rate of 1%, however, the income and EPS were both down during this time period. Year over year, net income was down 80% while EPS fell by 56%. Going forward, analysts expect a long term growth rate of 8% slower than the industry growth rate of 12%.

The growth rates are presented in the table below:

Growth Rates

3 Year

YOY

Revenue

1%

1%

Income

-24%

-80%

EPS

-9%

-56%

Growth Estimates

T

Industry

Next Year

8.10%

-3.90%

Next 5 Years

7.72%

12.22%

Profitability and Operations:

Coming to profitability and operations, gross margins last year were 50% compared to the 3 year average gross margins of 53%. Operating margins were also sharply down from 15% to 8% while return on equity fell from 12% to 4%. These are shown below:

Profitability & Operations

3 Year

1 Year

Gross Margin

53%

50%

Operating Margin

15%

8%

Net Margin

11%

3%

Return on Equity

12%

4%

Return on Assets

4%

1%

Competition:

To compare T to its competitors, key operational metrics for its peers were obtained. The peer group selected for analysis included Verizon (VZ), Sprint (S), Telephone & Data Systems (TDS) and Cincinnati Bell (CBB). The table below presents the peer analysis results.

Ticker

Market Cap

P/E

P/S

Lt D/E

ROA

ROI

GM

OM

T

181.78B

46.39

1.44

58.09

1.55

1.77

50

7.27

VZ

106.11B

44.19

0.96

139.85

4.53

7.01

58.62

11.62

S

8.06B

NM

0.24

177.35

-5.72

-6.67

43.54

0.22

TDS

3.63B

12.78

0.48

38.6

3.15

3.87

60.6

7

CBB

734.80M

102.84

0.51

0

0.69

0.79

53.69

17.74

Average

51.6

0.7

82.8

0.8

1.4

53.3

8.8

As shown above, AT&T trades at a premium to the average P/S ratio of the peer group. Verizon, its most direct competitor, has delivered higher margins and still trades at a lower P/E and P/S ratios. It does have a lower debt to equity ratio compared to its primary peers (VZ and S).

Valuation:

Valuation analysis was performed using two methods: relative analysis, and residual income method. For relative valuation, the multiple used below was developed based peer and broader market growth rate and multiple analysis. The relative valuation results are shown below:

Valuation

T

Next Yr Proj EPS

$2.54

EPS Growth Rate

8%

Future EPS (5 Yr)

$3.30

Expected P/E

14

Price 5 Yrs Out

$46.13

Unlevered Beta

1.06

D/E Ratio

61%

Current Tax Rate

35%

Levered Beta

1.48

Risk Free Rate

2%

Risk Premium

6.00%

Size Premium

-0.36%

Cost of Equity

10.5%

Fair Value

$28.71

Current Price

$30.65

% Overvalued

6%

As shown above, relative valuation results indicate that the stock currently trades at a slight premium to fair value.

Valuation analysis was also performed using residual income method with an analysis period of 5 years. The long term growth rate of 8% was also used as part of this analysis. The results are presented below.

Analysis results

EPS 2012 - $2.35

EPS 2016 - $3.2

Long-Term Growth Rate - 8%

Terminal Growth Rate - 3%

PV of Residual Income = $2.1

PV of Terminal Value = $6.0

Existing Book Value = $17.8

Intrinsic Value = $26

As shown above, the fair value for AT&T, based on a residual income-based model, is $26 a share. Taking an average of my relative valuation and a residual income based-valuation, my fair value estimate of $27.3 is obtained. I would avoid T at current levels. The yield should however provide some downside protection.

(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision)

Source: This Telecom Giant Is Expensive