AT&T Inc. Stock Is Approaching the End of Its Run

T stock looks good for now, but beware of a forthcoming peak

By Luke Lango, InvestorPlace Contributor

AT&T Inc. (NYSE:T) has been a big winner in this tax-reform-focused market. Ever since tax reform optimism started picking up in early November, T stock has rallied 16% higher. That is far better than the S&P 500‘s 4% gain during that time frame.

And although T stock has more room to run higher, I think a top will start forming in the stock in the low to mid 40’s.

This tax reform optimism will stretch on for a little while longer. The fundamental growth narrative surrounding T stock is also strengthening, driven largely by the repeal of net neutrality. DirecTV Now is also seeing positive subscriber growth trends, while states continue to opt in to AT&T’s public safety network, FirstNet.

Overall, things look about as good for AT&T as they have in some time. But this recent 16% rally means T stock is also closing in on multi-year highs.

Can T stock get back to those multi-year highs around $43? Yes. The repeal of net neutrality is a big deal for this company — as is tax reform.

But its tough to see why T stock should trade much higher than those multi-year highs given persistent cord-cutting headwinds.

No Need to Sell T Stock… Yet

T stock has had quite the run higher, but there is no need to fade the rally so quickly. After all, there is a reason for this big rally and its because AT&T is benefiting from multiple tailwinds right now.

Tax reform is a big deal for this company and AT&T is showing its appreciation by upping capital spending in the US by $1 billion next year and handing out $1,000 bonuses to its employees. AT&T’s effective tax rate last year was 32.7% on pre-tax profits of nearly $20 billion, so a cut in the corporate tax rate to 21% means T is going to have a lot more money to work with.

The repeal of net neutrality is also a big deal for AT&T.  T can now charge companies higher fees for higher speeds (which leads to more money), while showing preference for and pushing its own content and services, like DirecTV Now (which also leads to more money).

And that brings us to a discussion of DirecTV Now, which just passed the 1-million-subscriber mark. Growth in this segment will remain robust, as entertainment consumption shifts from traditional mediums to over-the-top.

But that also means AT&T’s traditional linear TV business will continue to struggle. Linear subscriber losses totaled 390,000 last quarter. While a 300,00 sub gain in DirecTV Now helped offset those losses, the company still lost a net 90,000 subs last quarter. This headwind is here to stay.

Consequently, while I believe T stock can rally to a multi-year high valuation on optimism regarding tax reform and the repeal of net neutrality, I don’t think the stock looks good at a premium to those levels considering that the cord-cutting headwind is here to stay. As such, I think T stock looks good until it hits certain multi-year high valuation targets.

What are those targets?

Well, the dividend yield is hovering around 5%. That isn’t too concerning. But once it drops to 4%, that will be the time to sell. A 4% dividend yield has historically represented a peak in T stock.

The trailing earnings multiple is around 19, while the trailing EBITDA multiple is around 7. Historically, 21 times trailing earnings and 8x trailing EBITDA has been the valuation peak for T stock.

The free cash flow yield is around 7%. Historically, T stock starts to max out around a 6% free cash flow yield.

Bottom Line On T Stock

By most valuation metrics, T stock still has some room to run higher before it hits peak valuation.

I think T stock can reach peak valuation in the near-term given the strengthening growth narrative.

Consequently, I’m long T stock, but am ready to sell when T hits peak valuation.

As of this writing, Luke Lango was long T. 

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