Why AT&T Inc. (T) Stock Keeps Getting Uglier and Uglier

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Years of low interest rates have left investors searching for yield, and a recent article in the Financial Times detailed the surge in corporate borrowing in recent years. U.S. corporate debt is up 275% over the past two decades, and credit ratings have deteriorated.

Why AT&T Inc. (T) Stock Keeps Getting Uglier and Uglier

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This comes at a time when a Federal Reserve rate hike in June seems increasingly likely. An IMF report cited in the article stated that companies holding $4 trillion in assets could be affected by an interest rate hike.

Last week I wrote an article on AT&T Inc. (NYSE:T) stock, citing AT&T’s financials as a reason for avoiding the stock. T stock has long been a dividend aristocrat, but its increasing debt load could threaten its 5% dividend yield.

AT&T has taken advantage of low interest rates to go on a buying spree. The company responded to slow growth in the telecom sector and pressure on margins with a strategy of acquisition-led growth, buying DirecTV Now in 2014 and agreeing to buy Time Warner Inc  (NYSE:TWXlast year.

Investors may have some questions. How did AT&T rack up this debt? How do AT&T’s financials look now? Could rising interest rates weaken AT&T’s balance sheet?

AT&T Stock: Merger Background

First, T bought DirecTV Now in May 2014 for $48.5 billion, issuing $17.5 billion in debt to finance the merger. Moody’s Investors Service responded to the merger by placing the company’s credit rating on review. When AT&T spent $18.2 billion on wireless spectrum licenses the following January, Moody’s downgraded it’s senior unsecured notes from A3 to Baa1.

But even this merger, one of the biggest in recent years, will be dwarfed by T’s purchase of Time Warner.

Last October, AT&T agreed to buy Time Warner, which owns CNN, for $85 billion in a cash-and-stock deal. The purchase price actually rises to $108 billion when Time Warner’s debt is factored in.

And since TWX shareholders will be getting T stock, the company will have to pay dividends to these new shareholders. Moody’s thinks AT&T’s annual dividend payments will increase from $12 billion to $14.5 billion.

Banks such as JPMorgan Chase & Co. (NYSE:JPM) and Bank of America Corp (NYSE:BAC) pledged $40 billion in loan guarantees for T.

AT&T sold $10 billion in bonds in February, mostly long-dated ones, and it is expected to borrow more soon to close the deal.

Measures of AT&T’s Financial Position

AT&T’s leverage has increased in recent years, with low interest rates encouraging the company to borrow money to fund deals that boost earnings-per-share. Let’s look at some measures of T’s debts and its ability to repay them.

Measures of AT&T’s Financial Position 1T stock’s debt-to-equity ratio fell from 0.775 in 2008 to 0.59 in 2010, and since then, it has climbed to a ratio of around 1. This means that for every dollar in shareholder’s equity, T owes $1 in debt. A lower debt-to-equity ratio is preferred to a higher one.

Measures of AT&T’s Financial Position 2AT&T’s net debt/EBITDA ratio has also increased, from 1.73 in 2008 to 2.33 in 2016. The company has a revolving credit facility in place that requires it to keep net debt/EBITDA below 3.5.

Its net debt/EBITDA ratio will probably increase further, but T executives think that within a year after the merger, the ratio will fall back below 2.5

Measures of AT&T’s Financial Position 3AT&T’s operating-cash-flow-to-total-debt-ratio increased from around 0.448 in 2008 to 0.56 in 2012, but then started decreasing, reaching 0.319 in 2016. The operating cash flow to total debt ratio measures a company’s ability to pay back debt if it devoted all of the cash coming in to repaying debt.

Unlike with the debt-to-equity and net debt/EBITDA ratios, in this ratio, debt is the denominator and a higher cash-flow-to-total-debt ratio is better.

Measures of AT&T’s Financial Position 4Likewise with T stock’s interest coverage ratio, which divides EBIT by interest expenses: This slipped from 6.71 in 2008 to 5.01 in 2016.

Will Rising Interest Rates Affect T Stock?

If the Fed raises interest rates, how would AT&T stock be affected?

It should be noted that taking on debt is not necessarily a bad thing. Managers need to find the cheapest way to finance their business, and during times of low interest rates and low inflation, it’s cheaper to issue bonds rather than stocks.

Debt is more like cholesterol; you can have good debts and bad debts. It’s generally safer to borrow at fixed rates than floating rates. Floating rate debt is often tied to some benchmark, and when interest rates rise, so do your interest payments. When you borrow at fixed rates, you don’t have to worry about this, and if rates fall, you can always take out a new loan at lower interest rates.

Fortunately for T stock, most of the company’s debt has been borrowed at fixed rates. If interest rates rise, it’s AT&T’s bondholders who would suffer, since new bonds with higher coupons would reduce demand for outstanding bonds.

T has already done some of the borrowing, raising $10 billion, but will probably borrow more.

Interest rate hikes could hurt AT&T stock, however, if they occur before the company has the chance to borrow the money it needs to complete its purchase of Time Warner. A New York Times article from last year suggests this.

I don’t think debt is an existential threat to T stock. But sustaining AT&T’s dividend may become more difficult given its debt load and high capex. The risks seem to outweigh the possible rewards, and AT&T stock doesn’t look so attractive.

Again, to learn more, you can read my article from last week, available here.

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/06/att-inc-t-stock-keeps-getting-uglier/.

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