AT&T Stock Is a Value Trap

On the surface, AT&T (NYSE: T) may look like a compelling investment. It is one of the largest telecommunications companies in the world, and T stock has a forward price-earnings ratio of under nine.

4 reasons why T stock will end its sideways trading soon

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AT&T even has a 6.2% dividend yield, one of the highest among U.S. mega-cap stocks. But a closer look at AT&T reveals a company and a stock that are in a tough spot.

Over the past five years, the S&P 500 is up more than 50% overall. In that same stretch,  AT&T stock price has floundered, losing  about 7.5 %.T stock is showing all the signs of a potential value trap.

Declining Businesses

The first place to look when assessing AT&T’s situation is its businesses. First and foremost, AT&T’s DirecTV premium cable TV service is in major trouble. In the first quarter alone, DirecTV lost 661,000 customers,representing an 11% annualized decline.

“It has 1.6 million customers on two-year price locks that expire in the next three quarters, and I think it is likely it loses the NFL after the 2019-2020 season,” former hedge fund manager Enrique Abeyta says.

AT&T’s trailing 12-month gross video profits peaked in the fourth quarter of 2016 and have  steadily declined ever since. Abeyta estimates at least half of AT&T’s Entertainment Group’s remaining EBITDA of around $10 billion is at risk in the long-term.

It’s no secret that AT&T’s wireline business isn’t in much better shape. Its EBITDA dropped 10% in Q1, and its operating income tumbled 22%.

The wireless business was the saving grace for AT&T for years. However, that market is now nearly completely saturated. As a result, the major players must now eat into each others’ margins by competing on prices and promotions.

From Bad to Worse

Nearly every business gets hit hard by recessions, but Abeyta, the former hedge-fund manager, says AT&T may be particularly exposed during the next downturn.

“In a recession, I think the cord-cutting (especially at high-priced DirecTV) will accelerate like nothing you have ever seen,” he says.

When times are good, consumers may keep paying for products and services they no longer need. However, when times get tough, those services are first on the chopping block.

In 2009, magazine and newspaper subscriptions nosedived. Prior to the recession, people kept those subscriptions simply out of habit. When the economy eventually recovered, there was no need for customers to go back in time and resubscribe.

Abeyta says AT&T’s EBITDA will decline 10% in 2021 even if the economy holds up. In the event of a recession, it could fall 25%.

Finally, AT&T has a massive debt load following its acquisition of Time Warner. Even after its planned debt paydown, Abeyta estimates AT&T’s 2021 net debt/EBITDA ratio will be a staggeringly high 3.5.

Is AT&T Stock a Value Trap?

A while ago, I wrote a story on the nine signs of a value trap.

The first sign of a value trap is declining revenue. In this instance, AT&T appears to pass the test, since its revenue was up 17.8% last quarter. However, another red flag is revenue growth from one-time sources, such as buyouts. AT&T’s $85 billion Time Warner buyout certainly counts as a one-time event. T stock fails that test.

The second sign is a suspiciously low PE ratio. AT&T stock’s forward PE of just nine certainly seems to fit the bill.

The third sign of a value trap is a troubled sector, characterized by even the top companies in the space struggling. Wireless providers have definitely been struggling, and cable TV has been challenged for years.

The next red flag is an extremely high dividend yield. AT&T stock yields 6.2%, the high end of its five-year range and an extremely high payout compared to the S&P 500 average.

Extreme debt levels are the next red flag, one that I already covered above.

New competition is another sign of a value trap. Netflix (NASDAQ: NFLX) may not be brand new, but it’s relatively new competition for cable TV providers.

The next red flag is a company with a product that is a fad. Nothing about AT&T is trendy enough to be considered a fad, so it passes that test.

Finally, if a stock has true value, insiders will be buying it. Going back to February of 2018, the vast majority of AT&T’s insider transactions have been buys, not sells. T stock passes that test.

I’d say comfortably that failing seven out of nine tests is a strong indication of value-trap status for AT&T stock.

As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.

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