Despite its decades-long presence, AT&T (NYSE:T) has become a risky investment. AT&T stock faces a crushing debt burden and high dividend obligations as it experiences a fundamental transformation in its industry. Even after recovery from the December lows, the stock price has fallen by more than 25% from its 2016 peak.
However, its challenges appear manageable. Moreover, I think the potential of 5G could turn the stock around. Hence, AT&T should rise above the following three risks to the future of the company.
Service Bundles
Verizon (NYSE:VZ) took a less costly strategy in making 5G wireless the focus of the company. AT&T paid $85 billion for Time Warner and $48.5 billion for DirecTV. With these purchases (and the debt that comes with them), AT&T has taken a riskier strategy in trying to sell service bundles.
Our own Laura Hoy has outlined the risks and possible payoffs of this strategy well. I think she has a more optimistic view of this gamble as I worry about content costs. Netflix (NASDAQ:NFLX) has placed intense pressure on its balance sheet to stay ahead in the content race. The costs AT&T will face in fighting this battle could weigh further on the stock.
However, I see it as a risk that makes sense. If this move pays off, AT&T will own a powerful ecosystem, as Hoy says. However, if it fails, the company holds options. Time Warner’s content assets will still hold value, while DirecTV can reach those without other forms of broadband access. If AT&T needs to sell either of these assets, I see the worst-case scenario of the bundle option as a manageable loss.
Sprint/T-Mobile Merger
The profit margins of all the major telcos have long taken a beating as competition from T-Mobile (NASDAQ:TMUS) forced both AT&T and Verizon to cut costs, and by extension, profit margins. Bulls in AT&T stock felt hopeful that the long-awaited union of T-Mobile and Sprint (NYSE:S) would finally happen with the approval of the Federal Communications Commission.
However, with the Department of Justice wanting to block the merger on antitrust concerns, prospects from the merger remain in doubt.
I do not think owners of AT&T stock have to worry. As I said in a previous article, a merger will occur in all likelihood even if a merger does not happen. Sprint remains heavily in debt. They likely cannot gain the financing to upgrade their network by themselves. If their situation forces them to liquidate, the other three major telcos will buy their assets.
Some have floated the possibility that Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) or Apple (NASDAQ:AAPL) could buy Sprint. This could happen. However, the tens of billions in costs required for a 5G buildout would put place tremendous pressure on either firm despite massive cash reserves.
Sprint also holds nearly $40 billion in debt. Couple that with likely competition, and it becomes a huge expense that probably will yield little profit.
Financials
Without question, high debt levels have hampered AT&T stock. AT&T holds over $175 billion in debt vs. just under $114 billion for Verizon. Further, Verizon’s supports a dividend yield of almost 4.1%. AT&T’s payout comes in at over 6.3%. Moreover, since the company has hiked this dividend every year for the last 34 years, any end to that streak would devastate AT&T stock.
However, thanks to the discounted stock price, AT&T trades at a forward price-to-earnings (PE) ratio of just 8.9. It also trades at about five times cash flow, well under the S&P 500’s average of about 14.
Investors should also note that the company earned almost $20 billion last year and generated more than $22.8 billion in free cash flow. This allows AT&T to meet $13.8 billion in dividend obligations, thus benefitting shareholders.
Also, analysts predict an average profit growth rate of 2.53% per year over the next five years. While that sounds lackluster, it should keep AT&T out of trouble. That estimate could also rise once more customers switch to 5G.
AT&T and its peers have each spent tens of billions on network construction. That investment will soon pay off. Once the network starts earning ever larger profits, not only will the company meet dividend and debt obligations, but it also should send AT&T stock much higher in the coming years.
Concluding Thoughts on AT&T Stock
Both business and financial uncertainty face AT&T. Still, I think Wall Street has overreacted to the three biggest concerns surrounding the company. The gamble with service bundles remains risky, but they can afford to take that risk. Moreover, the company’s position in wireless remains stable no matter the outcome of the proposed merger of T-Mobile and Sprint. Further, while AT&T’s debts and dividend obligations should cause concern, but I think the company can manage those issues.
It should overcome these challenges thanks to the potential of 5G wireless, which will become an indispensable part of the economy and cars, factories, health care facilities, smart cities, and other critical applications will depend on the technology.
Like the internet and the smartphone before it, once the public adopts 5G, they will have trouble imagining their lives without it. Best of all, we will likely have a world with only three 5G companies, creating what I called a “wireless Big Three” in previous articles.
In the end, AT&T offers a massive dividend. It also gives stockholders ownership of what will become a powerful oligopoly at a bargain multiple. That in itself makes it a risk worth taking.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
