AT&T Inc. (NYSE:T) stock hasn’t had a good go of it so far in 2017. T stock is down more than 10% this year, and that’s about to get worse today thanks to news that Sprint Corp (NYSE:S) is working on a deal to partner up with Comcast Corporation (NASDAQ:CMCSA) and Charter Communications, Inc. (NASDAQ:CHTR).
AT&T’s losses this year come despite solid gains for the market as a whole, and that’s not necessarily a new phenomenon. AT&T stock actually has declined modestly over the past decade, although including dividends, the shares have performed roughly in line with the S&P 500.
There are reasons to believe that underperformance may continue.
T stock isn’t a complete dud. It’s reasonably cheap, trading at about 13x 2017 analyst EPS estimates. The benefits of its merger with Time Warner Inc (NYSE:TWX) are on the way, and AT&T still is digesting its acquisition of DirecTV. Not to mention, it’s a solid income pick thanks to its 5% yield.
But there are real challenges ahead — namely concerns about its place in the telecommunications and media ecosystems. Investors looking for outsized returns should look elsewhere. Here are three reasons why:
The most pressing challenge for AT&T is in its wireless business. The U.S. wireless space is starting to resemble the former domestic airline business, with price competition eroding margins across the industry.
Sprint has aggressively priced its plans to take share from industry leader Verizon Communications Inc. (NYSE:VZ). Its recent offer of one year of free data was described by one analyst as “arguably the most aggressive promotion in the history of the U.S. wireless industry.” Sprint’s pricing, coinciding with similar promotions from T-Mobile US Inc (NASDAQ:TMUS), have allowed both to steal business from Verizon and #2 AT&T.
AT&T, in fact, saw its postpaid subscriber decline in its first quarter. Perhaps a larger concern is that AT&T discontinued revenue guidance, citing “the unpredictability of wireless handset sales”.
That uncertainty has weighed on AT&T stock, and the industry as a whole. VZ stock has performed even worse, declining 14% YTD. A long-awaited merger of Sprint and T-Mobile could help the industry by reducing competition. But in the meantime, there has to be real concern about subscribers and margins in AT&T’s wireless business.
The Time Warner Media Business
The AT&T-Time Warner tie-up makes sense in combining content with AT&T’s various distribution platforms. But it brings its own challenges as well.
Notably, nearly 40% of Time Warner’s 2016 revenue, per its 10-K, came from its “Turner” division. That business, which includes cable networks TBS and TNT, drove more than half of segment-level operating profit as well.But that’s a challenged business at the moment. Stocks like AMC Networks Inc (NASDAQ:AMCX) and Discovery Communications Inc. (NASDAQ:DISCA) have come down sharply due to “cord-cutting” concerns.
Further weakness in the Turner division might not have a huge effect on overall AT&T earnings. But the sum of declining wireline business, margin and subscriber pressure in wireless, and potential erosion in Time Warner’s profit center means earnings growth may be hard to come by.
At the moment, AT&T probably can generate enough cash flow to maintain its status as a quality dividend stock. But that’s not enough to grow its dividend by more than a penny a year increases it’s offered of late.
Without that kind of growth, it’s difficult to see much, if any, upside in AT&T.
The Future of T Stock
The promise of an integrated content and delivery company sounds good on its face, but AT&T needs to actually have the quality content and win in the delivery business as well. Time Warner’s content is desirable. Warner Bros. is the world’s largest studio based on revenue as of the end of 2016, per the TWX 10-K. HBO is a hugely desirable asset that should easily transition to the streaming world.
But AT&T is in second place in wireless. DirecTV lags cable providers like Comcast and Charter. Streaming service DirecTV Now, after a much-hyped launch, has seen minimal subscriber growth.
Meanwhile, AT&T’s debt is growing. InvestorPlace contributor Laura Hoy argued this month that the rise in debt — driven by the Time Warner and DirecTV acquisitions — is manageable, and that’s likely true. AT&T stock isn’t going to zero, to be sure. But higher interest expense can be a drag on earnings. If margin compression becomes a factor — and AT&T still is guiding for an expansion this year — that combination could lead earnings growth to stall out.
Even at 13x EPS, that’s enough to keep T stock flat, at best. That’s not a terrible outcome, admittedly. In this environment, a 5% yield will satisfy many investors, even if AT&T stock doesn’t gain on its own. However, investors looking for more might want to look beyond T stock.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.