Today, we’ll look at AT&T (NYSE:T), the telecommunications company fighting for market share along with many other competitors. Among its more popular offerings are wireless voice communication, long-distance and roaming services, as well as landline voice services. It sells handsets, wireless computers, personal computer wireless data cards and accessories.
What you might not know is AT&T also offers application management, security service, integration services, customer premises equipment, government-related services, and satellite video services, data services, Internet access and network integration, data equipment and U-verse services, as well as DSL/broadband, dial-up Internet access and Wi-Fi products.
One of the key driving factors for AT&T is that the company is in a seemingly never-ending war with myriad competitors, though it is the No. 2 player in the U.S. Still, telecom services are, at this point, a commodity. That means the ultimate winner is going to be the company that markets the best and has the best customer service. Margins will get increasingly thinner.
Analysts looking out five years on ATT stock see annualized earnings growth at a tepid 6.1%. While that’s around twice the growth rate of the last five fives, but it’s still pretty slow. At a stock price of $36 on trailing 12-month earnings of $3.43 (through the first quarter of 2014), the stock presently trades at a P/E of 10.6. But analysts think that earnings for calendar 2014 will be worse, at $2.70, and so it’s trading a somewhat richer 13.5 times expected 2014 earnings.
Looking at AT&T’s financials, the company has $3.8 billion of cash on hand but carries a whopping $80.4 billion in debt. Fortunately, trailing 12-month free cash flow was a handsome $14.4 billion so debt service is manageable, and sufficient to continue to pay out its dividend of $1.84, for a Dow-leading 5.2% yield. I have some concerns, however, about the increasing competition affecting cash flow going forward. The company’s run rate over the past few years has been climbing, and the company projects that by year-end its free cash flow slide further to $11 billion. That leaves little room for increasing dividends, which have risen 12.2% over the past five years.
There have been no insider purchases over the last six months, and that’s a concern when coupled with the free cash flow issue. If AT&T’s rumored $60 billion-plus acquisition of DirectTV comes to fruition, it’s likely to put further pressure on finances.
Placing a 13.5 P/E on AT&T, with projected 2017 earnings of $3.22 per share, gives us a price target of $38.86. That’s practically no growth from here over the next three-plus years. While a focus on dividends alone suggests that the stock is a buy, a more penetrating analysis – the 5-year PEG ratio – tells an entirely different story.
The PEG ratio is calculated by dividing a stock’s forward PE ratio (currently 13.5 for AT&T) by its projected, annualized earnings growth rate for the for the next five years. AT&T stands at a bloated 2.28, which means my recommendation is a solid “Sell”.
A buy signal is a 5-Year PEG below 1.20, which means AT&T’s stock would have to lose one-third of its value, falling to $24, to justify a buy at the current projected growth rate. Alternatively, analysts would have to see the company’s future five-year annualized growth rate rising to 8.8%. But I don’t see that happening, given the decline in margins in the wireless business and the competition for market shares gets increasingly fierce.
The message the 5-Year PEG is telling retirement investors that despite the 5.2% dividend, they’re taking on too much risk of a big capital loss to continue holding AT&T.
About Lawrence Meyers
Larry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at [email protected]