AT&T (T 0.27%) was once considered a stable stock for long-term investors, but it lost more than a third of its value over the past five years. That decline can be attributed to competitive headwinds in the wireless market, the slow death of its pay-TV business, its debt-fueled acquisitions of DirecTV and Time Warner to offset that secular decline, and its costly 11th-hour attempts to build a streaming media ecosystem to counter the cord-cutting trend.
The pandemic exacerbated that pain by disrupting WarnerMedia's theatrical releases and its production of new content. All those headwinds made it tough to invest in AT&T, even as its price-to-earnings ratio dropped to the single digits and its dividend yield hit an all-time high.
But has the market been too obsessed with AT&T's weaknesses and paid too little attention to its strengths? Let's take a look at three green flags for the telecom and media giant's future to see if it's becoming a value play.
1. Reducing its leverage
AT&T's biggest mistake over the past decade was its debt-fueled "diworsification." Instead of improving its core wireless business, it acquired too many other companies to build a massive media business that had too many silos and incompatible moving parts. As a result, its long-term debt rose at a much faster rate than its total revenue.
AT&T ended last quarter with $155.4 billion in long-term debt. However, it expects its net debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio to gradually decline from a "peak" of 3.1 at the beginning of 2021 to less than 2.5 by the end of 2023.
It's reducing its leverage with big divestments and spin-offs. It recently spun off DirecTV (but retained a 70% stake in the new company) and divested its Latin American satellite unit Vrio, the mobile gaming publisher Playdemic, the tabloid media site TMZ, the anime platform Crunchyroll, and other non-core assets. It also sold some of its real estate.
The biggest spin-off of all will occur in mid-2022 when AT&T merges WarnerMedia's assets with Discovery (DISCA) (DISCK) to create a new media company. AT&T's investors will receive new shares of the spin-off, while the "new" AT&T will reduce its dividend to reflect that divestment -- which should free up even more cash to reduce its debt and expand its 5G networks.
2. Stable growth ahead
After the spin-off, AT&T expects to grow its annual revenue at a low-single-digit compound annual growth rate (CAGR) from 2022 to 2024, and for its adjusted EBITDA and adjusted EPS to both rise at a mid-single-digit CAGR.
AT&T expects to pay out 40%-43% of its estimated free cash flow (FCF) of at least $20 billion as dividends in 2023. That estimate implies its forward dividend yield will decline from nearly 8% today to about 6%.
That dividend cut might seem like a setback, but we should remember that reinvesting AT&T's massive dividend yield failed to give the stock a positive total return over the past five years. Therefore, that cash would arguably be better spent on improving its core wireless business to boost its revenue.
Several major analysts believe the new AT&T will fulfill its promises. Last month, Morgan Stanley analyst Simon Flannery upgraded the stock to "overweight" and predicted the streamlined company would be a "much clearer and focused communications business."
Earlier this month, Wells Fargo analyst Eric Luebchow upgraded AT&T to "equal weight" and said that even though it faced near-term challenges, he saw a "pathway" for the company to generate over 5% annual EPS growth and more than 10% FCF growth through 2025.
We should take these analysts' expectations with a grain of salt, but they suggest that the market is still underestimating AT&T's turnaround potential.
3. Inflation could generate tailwinds
Rising inflation and higher interest rates have crushed many high-growth tech stocks over the past few months. However, those macroeconomic headwinds could actually become tailwinds for AT&T as rattled investors rotate back toward cheap blue-chip tech stocks with high dividends.
AT&T will still face an uphill battle this year, but its forward price-to-earnings ratio of seven should limit its downside potential. Verizon (VZ 0.83%), which could be another safe haven stock in an inflationary market, trades at nine times forward earnings.
Even if AT&T reduces its forward yield to about 6% after the WarnerMedia spin-off, it would still be much higher than the 10-Year Treasury's 1.7% yield, as well as Verizon's forward yield of 4.8%. That attractive yield, along with its low valuation and clearer plans for the future, could make it an appealing stock for income investors again.
Keep an eye out for a rebound
AT&T isn't a screaming buy yet, but it might fare better than other battered high-growth stocks this year. Therefore, investors should keep this stock in mind while hunting for safe-haven stocks in this wobbly market.