I can see why an investor would be interested in trying to time the bottom in AT&T Inc. (NYSE:T). After the ~15% drop in AT&T stock since mid-March, T stock now offers a tempting 5.4% dividend yield and trades at just 12.4x 2018 analyst EPS estimates.
The new iPhone from Apple Inc. (NASDAQ:AAPL) should arrive later this year, despite reported production delays. The acquisition of Time Warner Inc (NYSE:TWX) seems likely to close. AT&T stock is a long-time income investor favorite and a 5%+ yield looks hugely attractive. And, now it’s available at a cheaper price.
But I’m not interested in chasing T stock, even at these levels. There are real concerns across the business. AT&T stock does look cheap — but there are a lot of reasons that it should be cheap.
Margin Pressure Could Hit AT&T Stock
The core problem for AT&T, and T stock, at the moment is wireless competition. Smaller rivals Sprint Corp (NYSE:S) and T-Mobile US Inc (NASDAQ:TMUS) finally have gotten their act together. As a result, those smaller carriers have taken share from AT&T and market leader Verizon Communications Inc. (NYSE:VZ). In fact, AT&T posted a surprise loss in net postpaid subscribers in its Q1, which only added to the pressure on AT&T stock.
Those market share losses have a dual impact on AT&T margins. Losing postpaid subscribers results in deleverage of AT&T’s high fixed costs. Every additional subscriber adds revenue at limited costs; every lost subscriber takes away the same amount of revenue with very little savings. With Sprint, in particular, rolling out ever-more aggressive promotions, AT&T and Verizon have had to cut their own effective pricing, further pressuring margins.
The fear of further margin compression has fueling the recent price decline in AT&T stock. And it’s likely not getting any better soon. T-Mobile posted a strong Q2 report last week, and no doubt some of its growth came from former AT&T customers. All the while, Sprint continues to ramp up its promotional activity.
There simply isn’t much growth left in the overall U.S. wireless market — so the ‘Big Four’ are basically cannibalizing off each other for share. AT&T appears to be losing, at least of late, and even if it holds its share, profits likely will decline. That’s a big problem for T stock investors.
No Other Drivers For T Stock
Obviously, AT&T’s business goes beyond its wireless offering. In fact, its Business Solutions segment drives a just over half of the company’s profit. But news there isn’t great, either.
Earnings in that business were basically flat in 2016 (up less than 2%), according to the 10-K, and declined in Q1. With myriad smaller competitors like Twilio Inc (NYSE:TWLO), 8×8, Inc. (NASDAQ:EGHT) and Vonage Holdings Corp. (NYSE:VG) targeting B2B communications, particularly for small and medium-sized businesses, pressure could continue to hit that key segment as well.
The Entertainment Group saw profits rise in 2016 thanks to the DIRECTV acquisition, completed during 2015. But the U-Verse and DSL customer bases are falling quickly, and DIRECTV traditionally has been a low-growth business itself. AT&T now is running headlong into ‘cord-cutting’ concerns, between subscriber pressure at DIRECTV and its exposure through the pending acquisition of Time Warner Inc (NYSE:TWX).
Over half of Time Warner profits come from the Turner segment, including cable networks TBS, TNT, and CNN. The media business is in upheaval, and most content providers have seen their stocks come down over the past 18 months. With DIRECTV NOW growth stalling out, AT&T could see declines in this segment, too, once the TWX deal is done.
This simply isn’t a terribly healthy business across the board. That’s an obvious problem for AT&T stock. Combine that with the increasing amount of debt, and T stock could have much more downside to come.
AT&T Stretches Its Balance Sheet
One the Time Warner deal closes, AT&T will probably have a whopping $170 billion in debt on its balance sheet. Against a likely EBITDA base of around $60 billion, it’s not enough to push T stock to zero — or likely close.
But the combination of ballooning debt — and interest expense plus potentially lower profits — is a dangerous one. And it means there’s real risk to AT&T stock, even as it bounces off a 52-week low.
This doesn’t look like a case where the market is overreacting to a single quarterly earnings report. Rather, it looks like investors are starting to understand the very real, and very negative, trends facing AT&T. If that’s the case, AT&T stock has further to fall.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
