AT&T (T -1.54%) and IBM (IBM -1.64%) were both once considered stable blue-chip stocks for conservative income investors. But over the past five years, AT&T posted a total return of negative 26% even after factoring in reinvested dividends. IBM generated a total return of negative 5%. Meanwhile, the S&P 500 delivered a total return of 96% during the same period.
AT&T and IBM operate in different markets, but both companies took on too much debt, expanded with ineffective acquisitions, and spent too much cash on buybacks and dividends instead of improving their core businesses.
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However, both companies have recently taken bold steps to reboot their aging businesses. AT&T spun off DirecTV last year, and it plans to spin off WarnerMedia through a merger with Discovery next month. It will subsequently focus on strengthening its core telecom business by expanding its 5G and broadband networks.
IBM jettisoned Kyndryl, which houses its managed infrastructure services unit, last November. Spinning off that struggling business, which had been a dead weight on the company's top-line growth for years, will enable it to expand its higher-growth hybrid cloud and AI businesses.
As smaller, more streamlined companies, AT&T and IBM management believe the companies can generate more consistent growth over the next few years. But is either beaten-down blue-chip stock worth buying right now?
AT&T's plans for the future
On a pro forma basis, which normalizes the year-over-year comparisons to account for its spinoffs and divestments, AT&T expects its revenue to grow by the low single digits in 2022, its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to increase 2% to 4%, and for its adjusted earnings per share (EPS) to increase 0% to 2%.
In 2023, AT&T expects its revenue to grow by the low single digits again, its adjusted EBITDA to climb 5% to 7%, and its adjusted EPS to rise 2% to 7%.
It expects its wireless and broadband businesses to consistently generate single-digit sales growth throughout both years, with the latter growing at a faster clip than the former. It also expects to increase its annual capital spending from $20.1 billion on a pro forma basis in 2021 to about $24 billion in both 2022 and 2023 as it upgrades its networks.
AT&T will reduce its annual dividend from $2.08 to $1.11 per share after the WarnerMedia spinoff, which will cut its forward yield from about 9% to 5%. It plans to fund its future dividend payments with about 40% of its free cash flow (FCF). AT&T's investors will also receive a 0.24 share of the new media spinoff, Warner Bros. Discovery, for each share of AT&T they own.
Those plans indicate that AT&T plans to reverse the past seven years, which were filled with disastrous, debt-fueled acquisitions, and become more like Verizon -- a stable but boring stalwart of the telecom sector.
IBM's plans for the future
Between 2022 and 2024, IBM expects to increase its annual revenues by the mid-single digits and to grow its FCF by the high-single digits.
It expects that growth to be led by its sales of hybrid cloud software (primarily through its subsidiary Red Hat), security software, and consulting services. By focusing on the hybrid cloud market, IBM plans to wedge Red Hat's open-source software between leading public cloud platforms like Amazon Web Services (AWS) and on-site private clouds.
Carving out that niche could tether IBM to the secular growth of the cloud market while avoiding a direct confrontation with the public cloud leaders. It also expects its streamlined consulting division to compete more effectively against market leaders like Accenture. That expansion could boost its recurring revenue by locking customers into stickier software subscriptions.
Unlike AT&T, IBM didn't reduce its annual dividend of $6.56, which equals a forward yield of about 5%, after spinning off Kyndryl. IBM spent nearly $6 billion of its $7.9 billion in FCF (excluding Kyndryl) on dividend payments in 2021, and it expects to generate $10 billion to $10.5 billion in FCF in 2022 before it levels off at high-single-digit growth rates in 2023 and 2024. That forecast suggests IBM won't reduce its current dividend, but its future hikes might depend on the pace and success of its hybrid cloud and AI investments.
Both stocks are cheap, but one is a better value
AT&T stock trades at just eight times forward earnings, while IBM has a forward price-to-earnings ratio of 12. Both stocks look cheap, but AT&T is the better value play for three simple reasons:
- Its core business is simpler and stronger.
- It's defending a leading position in the telecom market instead of carving out a new niche.
- It faces fewer competitive threats.
IBM's turnaround plan might work, but only if Amazon, Microsoft, and other cloud leaders don't gradually close the gap between public and private clouds with their own hybrid services. If they do, IBM could be locked out of that niche market and be forced to shift gears again.
