AT&T: A Diamond In The Rough?

Apr.30.12 | About: AT&T Inc. (T)

I loved watching recent panic selling in Apple (NASDAQ:AAPL) after iPhone activation numbers from Verizon (NYSE:VZ) and AT&T (NYSE:T) were down quite a bit over fourth quarter numbers. Everyone was claiming that Apple was in trouble, but in fact, they weren't. But how about those phone companies? As my readers know, I have been a bear on Sprint (NYSE:S) for quite some time, and I still am, after their latest quarterly report.

Now, I really haven't focused on Verizon and AT&T a lot, other than a few mentions in my Sprint articles. Even there, I don't discuss them in detail, all I say is that I would prefer the two giants over Sprint because they are in much better shape, and their sizable dividends make them very attractive investments. So today, I'm going to cover AT&T, since some of my readers want to know more about the company and its market position today.

Corporate/Executive Overview:

I usually don't touch on a company's management that much, unless they are doing something stupid, and you can probably guess which firm I am referring to there. But when you have a very established firm, and I think AT&T would fit that category, it is important to have great leadership, and they do. CEO Randall Stephenson has been at the helm since 2007, and before that had been COO since 2004. He has roughly three decades of industry experience. John Stephens, the current CFO and Senior Executive Vice President, took over his post last year. He has been with the company for two full decades.

I'm not going to cover every single executive, so for a full list and biographical information, click here. Why am I focusing on the executives list? Well, when you look for a stable company and a solid investment, you need to know who is running the place. Just look at recent events with Groupon (NASDAQ:GRPN), where their young CEO was drinking at a meeting with employees, and from one account, almost choked after a big swig. Does it surprise you that Groupon has dropped nearly 50% in the past 2.5 months, when you have a leader like that, who says that his firm needs to grow up (uh, look in the mirror perhaps?). You aren't going to find people like this at the top of AT&T; you will see dedicated leaders, high quality people that have decades of industry experience.

Quarterly Results:

AT&T recently reported their fiscal first quarter earnings. Everyone seemed to panic when iPhone activation numbers took a dive from fourth quarter levels. Fourth quarter of 2011 iPhone activations for AT&T were 7.6 million, while the first quarter of 2012 saw just 4.3 million. However, that was still up nicely from Q1 of 2012, where the company activated 3.6 million iPhones, and that number was up nearly a million from the year before that.

It was a very good quarter overall for AT&T, and here are just some of the financial highlights:

  • 19.9 percent growth in wireless data revenues, up more than $1 billion versus the year-earlier quarter.
  • 19.0 percent growth in strategic business services revenues.
  • 38.2 percent growth in consumer U-verse revenues.
  • Smartphone sales of 5.5 million, exceeding the previous first-quarter record, with about 30 percent of all postpaid smartphone subscribers on 4G-capable devices.
  • 726,000 total wireless net adds, with gains in every customer category.
  • Postpaid wireless churn of 1.1 percent, lowest level in seven quarters.
  • Postpaid wireless subscriber ARPU (average monthly revenues per subscriber), up 1.7 percent to $64.46.

All in all, it was a very good quarter. One thing that I heard mentioned after their report was that lower activations of iPhones can be a positive in some respects. How, you ask? Well, iPhones are very low margin for the major phone companies so a shift to other smartphone sales will increase gross margins, and they did. Remember, the real winner off the iPhone is Apple. Apple makes a killing off the phone, as we just saw in their recent report with sky high margins. Here's how AT&T's first quarter margins have fared over the past few years.

Q1 Margins 2009 2010 2011 2012
Gross 60.11% 59.44% 57.11% 59.42%
Operating 18.77% 19.56% 18.59% 19.17%
Profit 10.23% 8.03% 10.91% 11.26%
Click to enlarge

Gross margins rebounded to 2010 levels, and operating margins were up year over year. Net profit margins were up nicely over last year, and were at a four year high. Here's how their Q1 margins look when compared to their competitors.

Q1 Margins T VZ S
Gross 60.11% 59.92% 41.78%
Operating 18.77% 18.39% -2.92%
Profit* 10.23% 5.97% -9.88%
Click to enlarge

*These companies sometimes have large non-controlling interests on their balance sheet. For comparative purposes, I use the net income available to the company's shareholders. If you were to use the total net income number, AT&T would have a profit margin of roughly 10.4% while Verizon would be at 13.8%.

Balance Sheet:

AT&T's business is a capital intensive one since managing phone networks requires a lot of work and money. This means that AT&T will have a very large balance sheet, and the company had more than $260 billion of assets on its books at the end of Q1. I'll show a few financial ratios here that I follow when looking at a company. The numbers are their financial position at the end of Q1.

Financial Ratios 3/31/09 3/31/10 3/31/11 3/31/12
Current Ratio 0.6352 0.6092 0.5935 0.6385
Debt Ratio 63.04% 61.44% 57.90% 60.95%
Working Capital -$13,511 -$14,344 -$13,517 -$11,755
Click to enlarge

Generally, having more current liabilities than current assets is not a good sign, but in this business, it isn't that much of a big deal. I'd be more concerned if the current ratio was dropping, and it actually just saw a nice rise. In fact, working capital is at its best level (at Q1's end) in four years. Their debt (liabilities to assets) ratio did increase over last year's period, but is still at a healthy level. I don't think anyone is questioning AT&T's financial position right now.

However, it is worth noting AT&T's position compared to some of its phone company competitors.

Financial Ratios T VZ S
Current Ratio 0.6385 1.0261 1.8984
Debt Ratio 60.95% 60.34% 79.08%
Working Capital -$11,755 $599 $5,785
Click to enlarge

If you looked at these numbers, you would think that AT&T is in trouble. But it isn't. Remember, Sprint has lost more than $12 billion dollars in recent years and has a huge debt load that may eventually do the company in. If AT&T was in financial trouble, you wouldn't see a dividend or stock buyback.

Dividend and Buyback:

AT&T is a value lover's dream. The company bought back more than $2 billion worth of shares in the quarter. That amounts to more than 67 million shares. The buybacks will continue. Also, despite the fact that shares are near 52-week highs, the company's 44 cent per share quarterly dividend yields nearly 5.4% annually, one of the best dividends around. AT&T continues to pay out billions in dividends annually, and with the buybacks reducing the outstanding share count, it will allow them to further increase the already high dividend. Verizon also offers a nice dividend, around 5%, and Sprint has no dividend.

Conclusion - You could do much worse:

AT&T is a very stable company that is growing, although very slowly with revenue growth this year and next under 2%. Earnings per share are growing much faster, but a lot of that has to do with the buyback reducing the number of shares. There is some margin growth as well. The company has a very large customer base, in both wireless and wireline segments, and is activating the most iPhones of the big three US carriers.

AT&T may be considered a jewel when it comes to value stocks. The stock offers a very nice dividend and is actively buying back plenty of shares. Now, you won't find this name growing at high levels, and if you are looking for the stock to double in a short period of time, you won't see it happen. However, unless something dramatically changes, you won't wake up one morning and see this name down 20% like most of the other names that I personally follow.

AT&T is a great investment right now, for both value names and is position in the market. However, as I always suggest, buying names at or near 52-week highs doesn't make a ton of sense. Over the past three months, the name has rallied from $29 to $32.69, so investors looking for a better entry point should wait for a small decline, perhaps a dollar or two.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.