Telecoms have traditionally provided a backbone for the typical retiree's portfolio. A recession-proof business? Check! Incredibly high barriers to entry? Check! Copious free cash flows providing fat dividends? Check!
Err ... actually, on the last criteria -- fat dividends -- that isn't always the case. Today's match-up of AT&T and Sprint features a large U.S. player in Sprint that does not offer a dividend of any sort -- let alone a big one.
Does that mean that you should avoid Sprint, or simply that it's using any excess cash it has for better purposes? It's impossible to know with certainty which of these two stocks is the better buy today, but if we run them both through three different gantlets, we can get a better idea of what we're getting when we buy shares.
The first of these dynamics is the simplest: financial fortitude. Here, we want to see how a company would be affected -- over the long run -- if a major economic crisis hit right now.
If a company has lots of debt, not much cash, and negative free cash flows, then it would be in big trouble if the next Great Recession hit. If, on the other hand, a company had lots of cash, little debt, and lots of free cash flow, it could actually grow stronger as a result of a crisis: by buying up its own shares on the cheap, acquiring distressed start-ups, or simply undercutting the competition on price until they call "uncle."
Keep in mind that AT&T is valued at over 10 times the size of Sprint.
|Company||Cash||Debt||Free Cash Flow|
|AT&T (NYSE:T)||$52 billion||$126 billion||$19 billion|
|Sprint (NYSE:S)||$4.6 billion||$33 billion||$467 million|
Balance sheets of telecoms are never pretty. That's because the up-front costs associated with building out a nationwide network are onerous. That being said, once the network is in place, the cash from recurring revenue starts pouring in.
AT&T is the runaway winner here. Its use of leverage is more modest than Sprint's, and the company -- relative to its size -- has much healthier free cash flow streams coming in.
Next, we have a slightly murkier variable: valuation. While there's no single metric that can tell you how "cheap" or "expensive" a stock is, we build out a more holistic picture by consulting various data points.
|Company||P/E*||P/FCF||PEG Ratio||Dividend||FCF Payout|
Here we have a mixed picture. The two companies swap in terms of being cheaper on earnings and free cash flow ratios. AT&T has a very large and safe dividend, while Sprint offers shareholders nothing in terms of quarterly payouts.
At the same time, however, Sprint currently trades for half of AT&T when growth is factored into the equation -- via the price/earnings-to-growth ratio.
Put all of those pieces together, and I'm willing to call this a draw.
Sustainable competitive advantage
Finally, we have the most important, and difficult to ascertain, variable to evaluate: sustainable competitive advantage. Often called a "moat" in investing circles, a sustainable competitive advantage is the special something that keeps customers coming back to -- in this case -- one phone company year after year while holding the competition at bay for decades.
In the past, long-term contracts and free minutes on calls between people who used the same network provided a moat via high switching costs. No one wanted to deal with the headache of breaking those contracts, or going over their minutes. But that all changed when T-Mobile entered the scene by offering services without either one of these stipulations.
Since then, the key differentiator has to do with market share and potential multiple futures. AT&T currently has 33.4% of the U.S. wireless market, according to Statista. Sprint's share, on the other hand, has been shrinking for years now, and currently sits at 12.6%.
Sprint openly admits that its network isn't as good as AT&T's or other rivals', but has tried to parlay the small difference in network coverage -- versus large pricing differences -- into a competitive advantage. It's still too early to tell if that's actually going to win over customers in droves.
In the meantime, AT&T has been diversifying to become a full-fledged media company, with acquisitions of DIRECTV and the currently on-hold potential merger with Time Warner. Given that Sprint's attempts at merging with T-Mobile have gone nowhere, this again gives AT&T an upper hand.
My overall winner is ...
So there you have it: With a wider moat and stronger balance sheet, AT&T comes out as my overall winner. To be honest, however, I'm not particularly bullish on either AT&T or Sprint. I'm still decades away from retirement, and I tend not to focus too much on dividend payers. That's why I haven't made a call on either company in my CAPS profile.
There are still lots of ways that this industry could be disrupted, and no one knows how that could all shake out. My money is invested in the companies I believe will be leading the next round of disruption.