Investors primarily view U.S. telecom company AT&T (T 0.81%) as a retirement stock, a slow-growing behemoth that pays a juicy dividend to its shareholders. This is fair; the stock hasn't moved much and is lower today than a decade ago. Meanwhile, the S&P 500 has grown more than 200%
However, some interesting things are happening in the company that could set up the stock to make up some lost ground. There is a case that the stock might double in 2022. Let's explore how this could happen.
The stock is unpopular
The stocks that make big moves are rarely the ones everyone already loves. We need some adversity; AT&T doesn't have this problem. It's one of the least popular stocks on Wall Street. While the S&P 500 is up 28% over the past year, AT&T is down 14%.
There could be several reasons for this downward trend. Perhaps investors are unimpressed with AT&T's failure to make its entertainment and streaming businesses work. Maybe investors fear the company's high debt load in a market that might see rising rates. It's not a short-term trend, though. AT&T has been down over the entire past decade, which is (frankly) quite hard to do.
When stocks become so unpopular, a change in sentiment can set off the stock like a powder keg. AT&T's stock may have struggled, but its business has been all right, even with the mishaps in its entertainment business and its high debt load.
Today, the business is generating 75% more free cash flow than a decade ago. A growing company with a lagging stock price almost always moves higher if given enough time; fundamentals tend to tell the long-term story.
Just how cheap is AT&T?
AT&T has traded at an average price-to-earnings ratio (P/E) of more than 17 over the past decade, despite the downward pressure on shares after flubbing DirecTV and Time Warner. The wireless business is so resilient that the company has performed well overall despite these challenges.
The company has shed its DirecTV assets and will be spinning off its remaining entertainment and streaming businesses in a deal with Discovery (DISC.A) (DISCK) in 2022. Analysts currently estimate AT&T's revenue for 2022 at $158 billion, down 6% from 2021, and earnings per share (EPS) at $3.20, down from $3.32 for 2021. This likely reflects the loss of Time Warner's contributions to AT&T.
Using these estimates, the stock's current P/E is still just under eight, less than half of the stock's historical average. If the stock were to regain the valuation that it has averaged throughout the decade, it would double the share price from its current level.
Why the stock might double
For AT&T's price to go from $25 to $50 per share, there needs to be a dramatic change in sentiment. Once AT&T formally sheds its entertainment business, it will return to a pure-telecom business model. Additionally, the company is receiving $43 billion as part of the Discovery deal.
Debt reduction is an underrated aspect of this. AT&T pays billions each year in interest expense because of the massive $178 billion in total long-term debt it carries on the balance sheet.
AT&T has paid more than $7 billion over the past year in interest expense, subtracted from the company's profits on the income statement. If it weren't paying this interest, its net income and bottom line profits would be much higher. Ironically, the stock would be even cheaper if this were the case, because its EPS would be higher.
As part of the Discovery deal, the $43 billion debt reduction will wipe out roughly a quarter of AT&T's debt, and management is cutting back the dividend payout ratio to free up more cash flow for paying down more debt. Management is targeting aggressive debt reduction over the next couple of years, lowering its debt ratio from 3.4 times to 2.5 times net debt to EBITDA (earnings before interest, taxes, depreciation, and amortization), a target it wants to achieve by the end of 2023.
Investors might begin to value the stock higher once it returns to a pure telecom business and frees up all the money on the balance sheet that has been thrown away on interest expenses. If this happens, I don't see why AT&T can't make a significant comeback in 2022, potentially making it a massive winner after years of disappointing investors.