What happened
Shares of telecom giant AT&T (T +0.70%) fell 3.6% as of 9:50 a.m. ET Friday morning.
You can blame J.P. Morgan for that.
This morning, investment bank J.P. Morgan downgraded AT&T stock from overweight (i.e., buy) to neutral, and slashed the telco's target price by $5, to just $17 a share. Of course, even $17 is more than what AT&T stock cost at Thursday's close, and it's also about 17% more than AT&T stock costs after this morning's sell-off.
So if J.P. Morgan thinks AT&T stock is worth more than it costs, why doesn't this banker think you should buy it?
NYSE: T
Key Data Points
So what
The answer, in a word, is growth -- and also lead.
As J.P. Morgan explains in its note, "recent commentary from management" at AT&T points to increased competition from Verizon Communications, T-Mobile US, and others, resulting in slower-than-expected growth in AT&T's broadband and wireless revenue in the second quarter. StreetInsider notes also that revenue from AT&T's landlines businesses are under "pressure" as well.
On top of that, a high-profile series of articles from The Wall Street Journal this week, highlighting health and environmental concerns from legacy telephone lines sheathed in lead (some more than 100 years old), poses an "unquantifiable, long-term overhang for the stock" that could become all too quantifiable in the event the company is sued by citizens, by the government, or both.
Now what
As regards the company's valuation, J.P. Morgan admits that AT&T stock currently trades at a record low 5.6 times earnings before interest, taxes, depreciation, and amortization (EBITDA), which sounds attractive. On the other hand, however, most analysts polled by S&P Global Market Intelligence agree that AT&T's growth will be flat to negative over the entirety of the next decade. Factor in the financial risk from lead litigation, and there's good reason for this stock to be so cheap.
On top of all that, I should probably point out that even AT&T stock is arguably a lot more expensive than it looks. According to the latest data, AT&T generated a respectable $11.6 billion in free cash flow over the last 12 months. But at a combined enterprise value (EV) of nearly $275 billion, that still works out to an EV/free-cash-flow ratio of 23.7.
For a stock growing its profits in the strong double digits, that might be a fair valuation. For a stock growing its profits not at all, and subject to "unquantifiable, long-term" litigation risk, I'm afraid it's just too high a price to pay.
