Positive talk coming from Wall Street analysts about telecom giant AT&T (T 1.27%) is a breath of fresh air for investors. Shares of AT&T have struggled for years as the company built up and then dismantled a media empire. With it back to being a telecom company and reporting solid results, analysts have started to take notice.
A strong buy
Analyst Frank Louthan of Raymond James (NYSE:RJF) made the case for AT&T on Monday, upgrading his rating on the stock from outperform to strong buy, and he bumped up his price target to $24 per share.
The company's strong third-quarter report, and the contrast with a weaker report from rival Verizon, drove the upgrade. AT&T added 708,000 postpaid phone subscribers and 338,000 fiber subscribers during the third quarter, pushing wireless-service revenue up 5.6% and broadband revenue up 6.1%. This performance came despite a highly uncertain economy.
Verizon, on the other hand, managed to add just 8,000 postpaid phone subscribers during the third quarter. Within the consumer segment, the company lost 189,000 postpaid phone subscribers. Verizon blamed recent price hikes for increasing churn.
Louthan thinks shares of AT&T will continue to outperform Verizon for the next few quarters, although he noted that telecom stocks can still get hit hard during economic downturns. Regardless of the stock's performance, Louthan doesn't expect the company's fundamentals to weaken.
AT&T is a far more predictable business today than it was a few years ago. The story today is wireless and fiber. The company can invest in 5G and expanding its fiber footprint without needing to worry about fighting the streaming wars and pouring billions into content. And the dividend is much safer, albeit lower than it was before the spinoff of Warner Bros.
Could AT&T really soar 40%?
Here's the important thing to remember: AT&T stock is incredibly cheap. Years of pessimism amid a failing media strategy have driven investors away, plunging the stock price to levels that make little sense.
It trades for around $17.50 per share right now, which translates to a market cap of roughly $125 billion. The company expects to generate $14 billion of free cash flow this year, a number that's been depressed by some payment timing issues with its customers. Given the performance of the business, hitting that target shouldn't be an issue.
AT&T stock trades for less than 9 times the free cash flow (FCF) guidance. If the stock were to jump to $24, reaching Louthan's price target, the price-to-FCF ratio would still be just barely above 12. The best investors can hope for is slow and steady growth, so the shares certainly don't deserve a premium valuation. But they also don't deserve to trade at a massive discount to the broader market.
Based on its valuation, a gain of roughly 40% certainly isn't far-fetched. And if the company can boost FCF over the next few years, an even bigger gain is possible. Of course, this all depends on AT&T's business holding up reasonably well as the economy heads toward a likely recession. Thankfully, smartphones and wireless plans are essential for most people. As long as the company can keep executing well, like it did in the third quarter, the stock looks like a winner.