The Q2 results for AT&T (NYSE:T) provide the market with a fuller picture of the progress made with the integration of the DirecTV merger. The promise of the merger that closed roughly one year ago were massive synergies from cost savings and the ability to offer a one-stop shop for customers.
The stock trades near multi-year highs after touching $43.50 a couple of times over the last month. For several reasons, my research highlighted that the rally should've ended back in April. The top lasted for about a month before the extended low interest rate environment drove people further into dividend stocks. Now the question is whether the stock can keep heading higher.
The merger was supposed to provide the new AT&T the ability to add subscribers due to the triple play options of wireless, broadband, and pay-TV. The theory being that customers will prefer a bundled deal from a provider offering a simple billing, customer service, and installation process. In reality, customers go for the best of breed or cheapest option. A large behemoth in the middle of a big integration rarely offers either solution to the market.
For Q2, AT&T saw total video subscribers decline 49,000. The big gains in satellite customers were offset by a 391,000 reduction in U-verse customers. The pay-TV giant benefits from the lowered content costs for satellite customers, but the shift appears to defeat the promise of lower content costs on U-verse customers.
Broadband saw the same issue, with the Entertainment Group seeing a huge 110,000 decrease in subscribers though the IP broadband subscribers were up 54,000. Even the Business Solutions segment saw a 14,000 decline in customers.
The Mobility segment only added 257,000 domestic postpaid phone subscribers. The domestic phone churn rate remains incredibly low, yet the wireless giant isn't adding customers. AT&T ended last Q2 with 77.3 million phone subscribers and has only grown the total to 77.6 million in the year after the merger.
Source: AT&T Q216 presentation
The promise of cross selling services isn't coming to fruition. AT&T listed 21 million wireless customers that didn't have DirecTV and 15 million DirecTV customers that didn't have AT&T wireless. The numbers suggest that very few of these customers are opting for the bundling option.
Search For Yield
The bottom line is that despite AT&T claiming that the merger synergies are on pace for achieving a $1.5 billion run rate by end of the year, the Q3 analyst estimates are flat with last year. After only matching analyst estimates of $0.72 per share in Q2, the expectation is now for matching the $0.74 earned last year.
The cost savings initiatives were a no brainer, but without any revenue synergies one has to assume the promises of big EPS benefits beyond the current levels has to be questioned. After all, AT&T became the largest pay-TV provider right as cord cutting is in full force.
The stock trades at roughly 14x forward EPS estimates that appear aggressive. The end result is that AT&T is only a dividend play now with no reason to expect capital gains. The stock offers a big 4.5% dividend yield, but growing the dividend will be limited based on a 73% payout of free cash flow in the 1H of the year.
AT&T forecasts that the merger will lead to significant cash flow gains in the next few years, but the projected growth again appears aggressive with customer reductions. In addition, the huge debt load of $127 billion combined with the need to spend billions on the broadcast incentive spectrum auction going on now.
With AT&T only hiking the dividend roughly 2% per year, the following chart highlights the stretched position of the stock. The dividend yield is the lowest in the last five years. The situation is actually the reverse of 2011 when the stock traded at $27.50 and the dividend yield was up around 6%.
All of the financials suggest AT&T is now priced for perfection that won't occur. The market though might not care with the search for yield ongoing. Investors that want to keep owning the stock at these stretched valuations need to understand the reason for the rally.
Whether justified or not, the stock likely continues trading higher until interest rates reverse higher. At that point, investors will need to understand that the benefits of the dividend will likely be offset by capital losses.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
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