On the surface, AT&T (T 1.69%) stock has a number of attractive qualities.
It offers a dividend yield of 6.1% and trades at a price-to-earnings ratio of just 7.5. As one of just three large telecom operators in the country, AT&T is also highly profitable.
In its most recent quarter, the company generated $6 billion in net income on $30 billion in revenue, a reflection of its highly profitable mobility business and its status in an industry with high barriers to entry.
However, even with its low valuation, high dividend yield, and wide profit margins, AT&T isn't the slam dunk that some investors might think it is. Here's why.
Image source: Getty Images.
A massive debt burden
AT&T's market cap is $129 billion currently, but the company is carrying $133 billion in debt on its balance sheet, giving the company an enterprise value (EV), or what an acquirer would owe if it bought the company, of $262 billion.
The price-to-earnings ratio is the most commonly used metric for valuing companies based on earnings, but it's not the best one to use with a company like AT&T that has so much debt. It makes more sense to use a ratio based on enterprise value like EV/free cash flow. For a capital-intensive business with high capital expenditures, free cash flow is a better reflection of the health of the business, and on an EV/FCF basis, AT&T stock looks considerably more expensive.
T EV to Free Cash Flow data by YCharts
As the chart shows, on an EV/FCF basis, AT&T stock is about as expensive as it's been in the last decade.
Cash flow is also important to investors because the dividend is one of the primary reasons investors own the stock, and AT&T needs enough cash to support the dividend. In its third quarter, the company's dividend payout ratio was 52% based on its free cash flow. That shows the company can easily fund its dividend, but AT&T also slashed the payout by nearly half after its spin-off of WarnerMedia as it was previously paying out nearly all of its free cash flow in dividends.
Managing the interest payments
AT&T is currently paying around $6 billion in interest expenses per year, but in a rising interest rate environment, those payments could go up.
Nearly all of AT&T's debt is fixed-rate, which helps it avoid some of the risk in rising interest rates, but if the company needs to roll over debt, it will likely have to pay a higher interest rate. For example, the company has several different notes maturing in 2023, ranging from 1.05% to 2.75%. Considering the federal funds rate is now between 4.25% and 4.5%, it will need to pay a higher interest rate if it needs to take on new debt.
Finally, debt isn't the company's only problem on the balance sheet. It's also carrying more than $93 billion in goodwill, putting it at risk of a write-down as the company has already had two disastrous acquisitions, of DirecTV and Time Warner, and the near-$100 billion in goodwill shows that the company paid significant premiums for the acquisitions that are still on its books.
Taking into account its debt burden, EV/FCF ratio, rising interest rates, and sizable goodwill, AT&T stock has a number of risks that aren't apparent based on its P/E ratio and dividend yield.
That explains why the stock has fallen consistently in recent years, and why it still isn't cheap even if it may look that way. While the 6% dividend yield may look appealing, investors can likely find better yields with less risk elsewhere.
