U.S. telecom company AT&T (T 1.02%) had earned a reputation for being a slow and steady business and a retiree's ideal stock, thanks to a fat dividend. But changes over the past decade or so have tarnished its reputation and affected its stock price. In an effort to regain that reputation, more changes are coming soon: AT&T is spinning off its entertainment business and re-focusing on its wireless and broadband networks.
These latest moves aim to shed debt from the company's balance sheet and give investors a leaner business that can grow its earnings and produce stronger total returns. It sounds like a good plan, yet the stock still trades near its lowest level in a decade. Is AT&T a bargain, or is it cheap for a reason?
Image source: Getty Images.
Just how cheap is AT&T?
Share prices of the telecom giant have been down more than 25% over the past decade, an ugly experience for investors, even if the company's paid a large dividend during that time. AT&T's grown its earnings per share (EPS) by nearly 6% per year over the past five years, pushing its price-to-earnings ratio down to less than 7. Considering the stock has averaged a P/E of 17 over the past decade, AT&T looks like it's sitting on the clearance rack.
The most likely culprit here is AT&T's balance sheet, which carries a whopping $152 billion in long-term debt due to its massive acquisitions of DirecTV and Time Warner several years back (as well as recent investments in much-needed wireless spectrum). The company borrowed to fund the purchases, but since it's sold DirecTV and is about to shed the remainder of its entertainment business, AT&T's streaming dream ended up being a nightmare.
Previewing the "new-look" AT&T
The "new" AT&T will look a lot like the "old" AT&T; the company will spin off its entertainment business, WarnerMedia, in a deal with Discovery (DISCK) (DISC.A) that will form a new stand-alone company. AT&T will be left as a pure telecom and broadband company once again, and AT&T shareholders will walk away with shares of both entities.
AT&T is shedding roughly $43 billion in debt as part of the deal, freeing up much-needed financial breathing room. AT&T's management is taking the opportunity to free up more cash flow, cutting its dividend from $2.08 annually to $1.11 per share. The dividend payout ratio will be roughly 40% of the company's free cash flow, giving AT&T ammo to pay down debt further or invest in growing its communications businesses.
Management recently held an investor event that highlighted how society is entering a new age of connectivity with 5G, remote work, 4K streaming/gaming, and the internet of things (IoT), estimating that data on its network will increase fivefold in 2025. The company plans to invest accordingly to expand its network capabilities and accommodate this increased demand over the years ahead.
Investors might have varying opinions on AT&T's decision to quit its costly bet on WarnerMedia and streaming. Still, it seems that focusing on its core business makes sense at the very least, considering the tailwinds for growth moving forward.
Not all questions can be answered
How long will AT&T stay so cheap? Truthfully, nobody can know for sure, and the market likes to zig when you think it will zag. However, AT&T is now on a focused path forward, and the spin-off will provide financial relief to the company once it occurs sometime in the next few months.
The new dividend will still likely offer a 3% to 4% yield for investors, which is still solid for income investors. The potential for future growth as data consumption increases could spark total returns for investors, even if the tumultuous past decade creates a low bar to hurdle. If you believe in the company's vision, the stock's bargain valuation makes it as good a time as any to buy shares for the long term.
