When To Buy AT&T

Summary

• AT&T is back down near its low from November of last year.
• Shares trade at a slight discount to average valuation.
• I believe income investors should wait for a substantial discount, due to industry uncertainty.

AT&T (NYSE:T) is a company I've been avoiding for awhile now. Back in October I recommended selling AT&T on news that the company was making a massive acquisition of Time Warner Inc (NYSE: TWX). In my opinion that acquisition was too much after news that AT&T was already acquiring DirecTV. Furthermore, the telecom industry has been in upheaval, with all content going to the mobile internet and the old restrictions of cable and telecommunications becoming less and less acceptable to consumers.

I continue to believe that this upheaval is something AT&T will have to adapt to, and it is already behind its disruptive competitor, T-Mobile USA (TMUS). This upheaval has forced AT&T to offer unlimited data plans to customers because it was loosing market share to T-Mobile. The effects of unlimited data will be felt at AT&T: namely, accelerating demand for spectrum and more pressure on AT&T's network, which wasn't really set up for unlimited data use in the first place.

Shares have declined significantly since my latest article on AT&T back on April 26th. The telecom industry may be up in the air right now, but at some point there will be a good entry point into AT&T. This article looks at AT&T's investment prospects today.

Falling shares

Courtesy of Google Finance.

As you can see, shares of AT&T dropped down close to their lows back in November of last year, at the height of concerns over the sprawling series of acquisitions.

To further complicate things, wireless revenue dropped from $18 billion in the first quarter of last year to $17.2 billion this year, and overall revenue dropped from $40.5 billion to $39.4 billion. I've spoken about this on previous articles, but suffice it to say that this was due to a net loss of 190,000 postpaid phone subscribers. EPS ticked higher, from 72 cents in 1Q '16 to 74 cents, thanks mostly to low churn and higher margins. The company also turned in a decent performance in Mexico, as well as gains in broadband.

Outlook is still for EPS growth in the mid single-digits, with continued margin expansion. I am dubious on that forecast. I think AT&T will have a difficult time growing EPS by more than low single digits this year, and the biggest focus of management is doubtlessly the two giant acquisitions of DirecTV and Time Warner Inc.

Management of both AT&T and Verizon (VZ) often talk about the "heavy competitive pressure," and are in fact referring to T-Mobile, which does not pay a dividend, and is therefore able to put all of its cash flow into investing in a new network. T-Mobile has vastly improved its network over the past few years, and built it to handle "unlimited" data use per consumer.

Unlimited data offers, which AT&T made available earlier this year, might help protect AT&T's market share in the US, but it will also put high demands on the company's network, and so ultimately, a lot more spectrum is going to be needed. That means a lot more capital expenditure going forward.

I actually think AT&T has the means to be able to improve its network while paying a hefty dividend. This year AT&T expects $18 billion in free cash flow (which is operating cash flow minus capital expenditure), and the dividend should be only about $12 billion. That leaves an additional $6 billion in money to play with and put to capital expenditure if needed, and I believe that it ultimately will be necessary.

While I remain somewhat concerned about the acquisitions, there is something to say about offering customers 'bundling' options over broadband internet, mobile data and cable. AT&T is very much able to offer that. Things remain quite uncertain, but I am willing to tolerate a degree of uncertainty in this business for a discounted valuation.

Valuation & conclusion

Is AT&T cheap enough? Well, not quite, but it's getting there. As of right now shares are down at $36.62 and the yield is a generous 5.35%. Shares currently trade at 12.8 times trailing EPS, which is not bad. Over the last ten years AT&T has averaged 13.8 times EPS according to data from FAST Graphs. That means AT&T currently trades at a 7.2% discount to average price to earnings. That's not really enough, and if you think a 5.3% yield is anything special, AT&T was yielding as high as 5.75% just a couple years ago.

A 15%-20% discount to average valuation would be enough to get me to buy shares despite the uncertainty. A 20% discount to 13.8 times earnings would be 11 times earnings, or $31.70 per share or so, or about $5 per share lower than where it is today.

I believe that shares could get there, although probably not overnight. There's a great degree of uncertainty in the US telecom industry, and so dividend investors should demand a good discount to compensate for that. For this reason, I recommend dividend investors stay away from AT&T at this price. However, AT&T remains a solid business that can be bought at the right price.

If you're interested in AT&T, feel free to follow me here on Seeking Alpha. I also have a Marketplace service, where I have a 'big list' of stocks dividend investors can buy. I will write update articles on AT&T when doing so is both material and relevant.

Analyst’s 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.