AT&T: Still Undervalued Compared To The Industry

| About: AT&T Inc. (T)

AT&T Inc. (T) announced its earnings results for the 4th quarter of 2013 and full year 2013. Demand for mobile data acted as a booster for the company to perform above consensus quarter results. The company managed to beat analysts' expectations narrowly by reporting earnings of 53 cents per share on revenues of $33.2 billion. This was 3 cents ahead of the 50 cents EPS expectations of analysts polled by Factset. On the surface all appears well, therefore I will try to delve into the details to determine whether or not the stock is a buy.

Top Line Growth

At the outset the company reported a 2% rise in total revenues for the fourth quarter of 2013. This was majorly due to the 5% rise in revenues from the wireless segment. As the wireless segment is at the heart of the business and the major (56%) revenue contributor, its performance offset the 23% decline in the other segment.

Source: Investor Briefing

Looking at the Income statement the 4th quarter performance seems satisfactory, as indicated by a decline in the operating expenses of 46% drove mainly due to a 76% decrease in the selling, general and administrative expenses. However, this was offset by a 78% rise in the finance costs of the company for the 4th quarter of 2013.

The Wireless Segment showed a 4.5% uptake in revenue driven by a 16.8% rise in wireless data revenues from the year earlier. Wireless services' revenue also climbed up by 4.8% to $15.7 billion. The operating income's margin for the quarter stood at 21.4 %. Margin expansion was driven by a significant decline in operating expenses for the quarter down by 5.4%.

Source: Investor Briefing

This year the Wire-line segment seems under pressure from project VIP as its revenues dropped 1.4% and stood at $14.74 billion in Q4. The declining wire-line's voice revenue increased by 11% was the major reason behind the negative growth of the segment. However, this decline was offset by a rising growth of 5.6% in wire-line data revenues. The mixed performance of the segment resulted in a margin contraction for the quarter from 12% to 9.9% driven by higher operating expenses.

Bottom Line Growth

In the 4th quarter of 2013 AT&T managed to report a net income of $6.9 billion that is far higher than the loss of $3.9 billion during the corresponding quarter of the previous year. The diluted EPS turned to a positive value of $1.31 from a negative EPS of $0.68. The adjusted EPS increased by 20.5% to $0.53 in contrast to $0.44 last year. AT&T's net income for full year 2013 was $18.2 billion compared to $7.3 billion and the diluted EPS was $3.39 compared to $1.25 last year. The adjusted EPS for 2013 was $2.50 reflecting an increase of 8.2% compared to $2.31 of the previous year.

Source: Earnings Conference slides

This level of profits was mainly driven by the 14.1% decline in operating expenses relating to actuarial gains on benefit plans. This is also significant because last year AT&T recorded a $3.9 billion loss in the 4th quarter due to an actuarial charge of $114.4 billion (annualized value) that decreased to $98.3 billion in 2013.

Subscriber Growth

In Q4 AT&T got 566,000 postpaid subscriber contracts and that number was far less than the Q4 2012 subscriptions of 780,000 reflecting a decline of 27.4%. This can be related to the price war initiated by T-Mobile (NASDAQ:TMUS) by offering to cover AT&T's contract customers' $350 termination fees and $300 for trading in their phones. However, it was noted that AT&T managed to retain its customers as it responded to the competitor's offer by announcing $450 as an incentive for switching. This quarter had the lowest ever 4th quarter churn rate of 1.11% compared to 1.19% in the comparative quarter reflecting a decline of 8 basis points.

However, it is rather peculiar that the American telecom giant is not taking advantage of widespread growth opportunities in Asia and Africa and that it has still restricted itself to Europe a region that is showing a very slow response to adopting the 4G mobile broadband. A study discovered that Africa is the fastest growing mobile market with a 65% rise in mobile usage every year. In the presence of these opportunities, it seems time for the company to leave its stubborn fascination with Europe and diversify its business in the developing world.

Shareholder Returns

In 2013, AT&T Inc. bought back 366 million shares reducing its float by 6% to $13 billion. The amount invested in the share buyback program during the 4th quarter of 2013 was $1.9 billion and the company bought back 54 million shares. Other than this, the company maintained its 30-year trend of increasing dividends. The latest quarterly dividends increased at a rate of 2.2 % from 45 cents to 46 cents a share. Annualized dividends raised from $1.80 to $1.84 a share. Here it is important to mention that the company has a payout ratio of 130.81, that is more than 10 times the industry payout ratio. Adding the share repurchases and dividends the company returned $23 billion to shareowners in 2013 and that makes the shareholder return equivalent to 13%. Turning our focus towards the share price in the previous year AT&T showed a price decline of 1.26%, in contrast to the 65.52% appreciation in T-Mobile's stock price. This may be because the company is trapped in a detrimental price war with T-Mobile and Sprint (NYSE:S).

Source: Y-Charts

Future Outlook

AT&T has predicted that for the year 2014, 2-3% revenue growth and a mid-single digit uptake in the EPS, assuming no changes in the economy and excluding the impact of future stock buyback. For the revenues to grow the company is relying heavily on its wireless service and wire-line consumer revenues. AT&T's wireless segment's revenues are intertwined with Apple (NASDAQ:AAPL) since it is the biggest reseller of Apple phones in the mobile market. In Q4 the company claimed 93% of smartphone sales, however the percentage of iPhone sales was not mentioned. This indicates that the company may achieve its set revenue target as analysts expect iPhone sales of 55 million units after the launch of the high end iPhone 5S and the cheaper 5C. However, the company's future guidance indicates a decline in free cash flow to a level of approximately $11 billion down 20% from $13.6 billion in 2013 due to capital expenditures of about $21 billion. The company's LTE development and project VIP will largely contribute to the CAPEX.

Final Note

Despite the price war in the industry, AT&T Inc. managed to report positive earnings and cash flows. However, it missed analysts' expectations of new subscriber contracts because of aggressive pricing by T-Mobile. This competition can hurt AT&T's future performance. The company had transferred heavy returns to shareholder's wallets in the form of dividends and stock buy backs, but it seems iffy for the trend to continue in the long term; keeping in mind the company's cash flows and capital expenditure requirements. Declining free cash flows and rising CAPEX can make it difficult for the company to continue buying its shares. At a P/E ratio of 23.87 AT&T is trading at a cheap low compared to the industry's P/E of 63.33. This tempts me to rate this stock as undervalued.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article

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