AT&T Inc. (NYSE:T) has taken investors on a wild ride this year. T stock surged early in 2016, breaking out of a long-held resistance level. Shares topped $43 in late summer. However, T stock swooned to $36 by early November. The rise in interest rates and a controversial proposed merger with Time Warner Inc (NYSE:TWX) caused T stock to tank.
However, AT&T flipped on a dime following the election. Shares soared following President-elect Trump’s victory, and T stock is now back near $43. Will investors see new all-time highs, or is now a good time to ring the register?
T Stock Cons
Tons of Debt: Since 2011, AT&T has nearly doubled its debt load. Five years ago, it came with $64 billion in debt. That has since surged to $125 billion today. This doubling of debt has translated to less than 20% growth in operating and free cash flow over the same period.
AT&T is making plenty of acquisitions in an attempt to continue showing growth. The truth, however, is that the company’s U.S. business is not growing much. Thus, management must make big, risky moves to please shareholders. AT&T also using debt to fuel its large dividend without having to give up on expansion plans. This has worked fine in a low interest rate environment, but may offer less-than-stellar results in a rising interest rate environment.
Rising Interest Rates: Speaking of rising interest rates, T stock has a more direct problem there. Investors often consider T stock to be a bond alternative. It’s not hard to see why, either; T stock yielded more than 5% for much of the year. Compared to bonds and CDs, that looked great. And while AT&T’s token 2% annual dividend increases aren’t impressive, they beat the fixed interest payments you’d get on a bond.
Unfortunately, this bond-alternative status comes with a risk: as interest rates rise, the so-called yield tourists who bought T stock for dividends will leave. If you can go back to getting 5% yields on actual bonds, the appeal of owning T stock declines markedly.
We’ve seen huge selloffs in various REITs, utilities, and defensive consumer stocks that trade as interest rate proxies. Thus far, AT&T has avoided this. But, make no mistake, if interest rates continues to rise, T stock’s 4.6% yield won’t be enough to support the stock price at $43.
Mexican Competition Issues: AT&T has dumped a lot of money into Mexico over the past few years, and this has been viewed as a major growth catalyst for the company. I live in Mexico and I’m skeptical the strategy will work.
Carlos Slim’s behemoth, America Movil SAB de CV (ADR) (NYSE:AMX) still controls two-thirds of the Mexican market. And, Spanish telecom giant Telefonica S.A. (ADR) (NYSE:TEF) has secured the No. 2 spot with its Movistar brand.
AT&T bought several weaker brands and is trying to combine them into a legitimate competitor. There appeared to be an opening, as Mexico’s government had urged more competition in the sector. However, earlier this week, Mexico’s government said it is now pleased with America Movil’s profit margins. Thus, further competition isn’t needed.
Telefonica and AT&T can complain, but Carlos Slim is powerful in Mexico; their protests won’t amount to much. AT&T is left with the weakest network, wide gaps in coverage, and slow service, while up against a monopolistic market leader and a fairly strong No. 2 player.
T Stock Pros
Big Yield: AT&T might not have a lot of growth, but you can’t complain about the AT&T dividend. The company pays a 4.6% yield, after all. While that leaves the company vulnerable in the event of higher interest rates, a reversal in interest rates would make the T stock yield sparkle again.
There have been various interest-rate-rising scares, such as the 2013 Taper Tantrum. If the 2016 Trump-induced interest rate panic turns out to be a passing fad, T stock will stand out with its appealing income offering.
DirecTV Now: It’s a hit. AT&T appears to have a real winner on its hands with the newly-launched DirecTV Now product. It reached its December sales target in a single day, and the Amazon Fire Stick that powers the product went into back order almost immediately.
DirecTV Now offers more than 100 channels at a starter rate of just $35 per month, along with other perks such as discounted rates for HBO. Some analysts have criticized the service, saying the price point is too low to make much money for AT&T. However, as with many subscription services, the idea is start low, gather a large stable base, then gradually improve pricing. AT&T genuinely surprised many who view it as out of touch with millenials; it has a viable cord-cutting option in play now.
Time Warner Deal May Be Scuttled: AT&T announced a mega-merger with Time Warner earlier this fall. Supposedly, this merger was going to be the next big thing for AT&T. However, the market was skeptical, sending T stock lower.
As luck would have it, Donald Trump unexpectedly won the election. Trump and some of Time Warner’s media properties tussled during the election coverage. Perhaps relatedly, Trump clearly denounced the proposed merger. He said deals like this merger would “destroy democracy.”
That said, some members of his transition team appear to be okay with the merger going through. Still, there’s hope that AT&T, which already has plenty of debt and organization problems, will sidestep a potentially headache-inducing business combination.
Verdict
I find the balance of evidence in favor of avoiding T stock. With the stock nearly hitting new 52-week highs, investors are pricing in a lot of things going right. However rising interest rates, merger uncertainty, and the company’s increasingly debt-filled balance sheet all sound the need for caution. I’d wait for a sizable pullback before starting or adding to positions in T stock.
At the time of this writing, Ian Bezek owned TEF stock. He had no position in T stock. You can reach him on Twitter at @irbezek.
