Smartphones, especially Apple’s (NASDAQ:AAPL) iPhone, are bad news for the telecom companies that sell them. Just have a look at AT&T’s (NYSE:T) latest earnings, which came in better than Wall Street’s forecast, thanks to it not selling more iPhones in the second quarter.
That’s right: The nation’s biggest telecommunications company by market cap exceeded analysts’ average bottom-line estimate by a healthy 3 cents a share largely because fewer customers upgraded to iPhones, which AT&T subsidizes to make the wallet-busting gadget affordable to regular folks.
However, as has become all too common this earnings season, AT&T’s revenue came up short of Wall Street forecasts — and shares fell sharply during Tuesday trading despite the solid profit gains.
Defensive telecom stocks have been a bright spot in an otherwise turbulent year for equities. AT&T, a component of the Dow Jones Industrial Average, was up nearly 15% on a price basis for the year-to-date before Tuesday’s stumble, beating the broader market by 8 percentage points.
But is it a good bet going forward? Let’s have a look at the pros and cons:
Bond in drag. AT&T is a stock that acts kind of like a bond, so it’s sometimes called a “bond in drag.” The dividend currently kicks off 5% on a forward basis, and it’s considered safe and stable — that’s why AT&T makes InvestorPlace’s list of Dependable Dividend Stocks. Indeed, over the last five years the dividend has averaged 5.3%. Furthermore, with a beta of 0.45, AT&T is essentially 55% less volatile than the S&P 500. Yes, the stock lags when the market is going up, but it also holds up better when stocks are headed down.
Wireless growth. Landlines are history, so it’s promising that AT&T continues to gain steam in wireless services. Revenue from the wireless business rose 4.8% to $16.3 billion in the latest quarter, while operating income gained 18% to $4.9 billion. Expanding margins were the key, which peaked at a high of 30% — a whopping increase from 27% in last year’s period.
Strong fundamentals. Based on an equal-weighted measure of profitability, debt, earnings quality and dividend, AT&T scores an 8 out of 10 on the Thomson Reuters Stock Reports fundamental strength scale. In addition to the outstanding dividend, the telco benefits from comparatively high gross margin and a strong balance sheet — no mean feat in such a capital-intensive business.
iPhone 5. There was no new iPhone last quarter, and that did wonders for AT&T’s profitability. The company sells smartphones for, say, $99 or $199, but they cost a lot more than that. Apple charges carriers about $650 for each and every iPhone, and carriers have to eat the difference. A new iPhone could hammer margins — and profitability — in upcoming quarters.
Valuation. Shares are no bargain by relative valuation measures. By both forward and trailing earnings, the stock trades at steep premiums to its own five-year averages, according to Thomson Reuters data. Additionally, AT&T is hardly the most high-quality stock in the sector, at least by looking at return on equity. True, telcos never blow anyone away with ROE — something in the teens is par for the course. But AT&T, at 4%, is especially low. Verizon (NYSE:VZ), by comparison, has an ROE of 13.
Price-less. AT&T’s stock has enjoyed healthy price gains in 2012, but over long periods of time all the value has come from the dividend. That means you really have to commit to the stock through thick and thin. Over three-, five- and 10-year periods, AT&T only matches or even lags the S&P 500 on price alone. Add in the dividend, however, and you have a market-beater. For example, AT&T has generated a total return of almost 40% over the last five years, while the S&P 500’s return is a paltry 0.22%.
AT&T has had a remarkable run in 2012, making the stock looked priced for perfection, and then some. Just witness Tuesday’s sell-off on Street-beating earnings. Shares aren’t cheap at current levels, and more short-term outperformance may be hard to come by, especially because profitability should take a hit in the second half of the year.
That said, AT&T is a solid long-term holding for income investors. If you want stability and steady dividends — and can really commit to buying and holding this stock — AT&T is core constituent of any blue-chip equity income portfolio.
As of this writing, Dan Burrows held none of the securities mentioned here.