AT&T: Fool's Gold?

AT&T (T) management appears to have finally got the message on debt. The stock has finally rallied to multi-month highs over $32 as the CEO and CFO have remained steadfastly committed to paying down debt. The company continues making questionable moves changing over the leadership at WarnerMedia discussed in my previous article, but the stock has a clear path to $40 with a singular focus on reducing debt levels.

Clear Message

Randall Stephenson became the CEO and president of AT&T on May 9, 2007. During his tenure as the leader of the wireless and media giant, he has dramatically grown debt levels faster than revenues.

In the course of his dozen years at the helm, net debt grew to $180 billion at the peak and ended 2018 down at $171 billion. In all fairness, revenues are expected to hit $183 billion this year with a full year’s worth of WarnerMedia results.

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Data by YCharts

A big key to the story is the stock returns over this period. AT&T shareholders have watched the stock lose nearly 19% of its value during the tenure of CEO Randall Stephenson. The S&P 500 has gained nearly 90% during the period despite the financial crisis shortly after he took over as CEO.

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Data by YCharts

Now a lot of investors like to brag about substantial dividends due to the now 6.4% dividend yield. Clearly though, investors would’ve made far more money just owning the S&P 500 index. Over the course of this period, the S&P 500 index total return is up ~145% versus the total return of AT&T of only ~53%.

Anybody just looking at dividends is convinced they are making a great investment. Anybody buying the stock at nearly $40 when Stephenson took over the helm should be highly disappointed with the overall results.

Using the example of somebody buying $1 million worth of shares back in May 2007 at $40, the investor would have 25,000 shares. Those shares would now be worth only $800,000 with the stock down at $32.

An investor not paying attention to the details probably hasn’t realized that the capital position has lost so much money because the drip has only averaged about $16,666 each year or less than 1.7% of the initial value on an annual basis.

Where the investor gets excited is the dividend payout of $2.04 per year now pays the investor $51,000 annually and the company raises the dividend each year. The problem with the equation is that the shareholder would have an investment worth $2.45 million by just leaving it in an index fund and eliminating the single stock risk that has crushed investors in General Electric (GE) and countless other stocks in the past.

In essence, the dividends are fool’s gold. If an investor now swapped the S&P 500 index position worth $2.45 million for AT&T, that investor would now receive ~$157,000 in annual dividends.

Focus On Debt

For now, the management team appears to have finally got the message. Each and every time the CEO and CFO is paraded in front of the media and analyst community, both executives are clear to state that the internal goals are to pay down debt, not more M&A.

March 20, 2019 – CEO Randall Stephenson at Economic Club of Washington:

But I am focused on one thing, and that is paying that debt down this year. We took on $40 billion of debt to do it [Time Warner]. By the time we exit this year, we will have paid off $30 billion of it. And I can largely have that set aside.

March 13, 2019 – CFO John Stephens at Deutsche Bank Media, Internet and Telecom Conference:

We want to most importantly and always in the front of our list, pay down debt. We want to make sure that we pay down debt.

February 27, 2019 – CFO John Stephens at Morgan Stanley Technology, Media and Telecom Conference:

The company plans to use about $12 billion in cash after dividends – along with $6 billion to $8 billion from asset monetization – to reduce debt. The company expects to end 2019 with a net debt-to-adjusted EBITDA ratio in the 2.5x range.

January 30, 2019 – CEO Randall Stephenson on the Q4 2018 earnings call:

…we committed during our Analyst Day in November and in fact I would say we’re ahead of schedule on each of our key priorities, and as we said our top priority for 2019 is driving down the debt from the Time Warner acquisition, and I couldn’t be more pleased that how we close the year.

The question now is whether the debt talks are fool’s gold. The CEO made a key caveat in the discussion on March 20 that paying down debt was a goal for “this year.” The stock won’t rally into 2020 if the executives shift from this goal next year.

Cheap, Cheap Value

AT&T is extremely cheap for a reason, but the company should be able to close a lot of the multiple gap with top wireless competitor Verizon Communications (VZ). As much as my view questions the logic of the Time Warner merger, the stock has suffered far too much, if the management team stays on the debt repayment focus.

The market doesn’t expect much in the way of revenue growth for any company and the major 5G catalyst isn’t likely to show up until 2021 or after. For this reason, AT&T should close the forward P/E ratio gap with Verizon.

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Data by YCharts

Analysts forecast AT&T to earn $3.63 per share in 2020. At 10x, the stock rallies to $36.30. At 11x, the stock rallied to $39.93. At this level, AT&T reaches my $40 price target and the dividend dips back towards normal levels at 5.1%.

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Data by YCharts

Takeaway

The key investor takeaway is that as long as the AT&T executives stay on a singular focus of paying down debt with their excess free cash flows, the stock will close the P/E ratio gap with Verizon.

The CEO has made enough comments about only having this goal for 2019 suggesting an investor likely wants to get out when the stock rallies back to $40. The recent debt reduction could turn out to just be fool’s gold along with the concept of holding AT&T long term to collect the dividends.

Disclosure: I am/we are long T. 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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Reem Nori