Shares of telecom giant AT&T (T 3.40%) are historically inexpensive. Based on the company's guidance for 2023, the stock trades at a measly 7 times free cash flow. The dividend yield is also on the high side, coming in at around 7.35%.
There are a couple of reasons why investors may be excited about AT&T stock. First, the company's growth is slowing after a period of rapid subscriber gains during the pandemic. AT&T expects to gain just 300 thousand net postpaid phone subscribers in the second quarter. That's less than half of what it was typically gaining in 2021.
Second, AT&T still has a lot of debt left over from its failed foray into the media business. While AT&T has spun off and otherwise disposed of its acquired media assets, including WarnerMedia, its balance sheet is still riddled with debt. At the end of the first quarter, AT&T's total debt stood at $137 billion. Investors are right to be concerned about this mountain of debt in a rising interest rate environment.
A lead-coated wild card
AT&T investors now have another thing to worry about. The Wall Street Journal reported earlier this month that AT&T and other telecom companies have left lead-covered cables in the ground, under water, and on poles in various places across the U.S. As those cables age, lead can potentially seep into the soil and water and cause health problems. In another report a few days later, the WSJ indicated that AT&T's management have known about the risks associated with lead cables for decades.
It's impossible to predict how this might affect AT&T financially. The company could be compelled to remove this cable, and it may face lawsuits from anyone whose health has been negatively affected. In a statement released in response to the Journal, AT&T said that the reporting conflicts with long-standing science and the company's own testing. "The scientific literature and reliable studies in the U.S. and abroad give no reason to believe that these cables pose a public health issue or a risk to workers when appropriate safety measures are in place," read the statement.
The cost to remove lead cable can be significant. In 2021, AT&T reached a settlement with the California Sportfishing Protection Alliance to remove 8 miles of lead cable that were abandoned on the bottom of Lake Tahoe. The lawsuit claimed that the cables were damaged and releasing lead into the lake, although AT&T's own testing did not find that to be the case. Still, the company agreed to set aside $1.5 million to remove the cables.
An analyst downgrade
J.P. Morgan analyst Philip Cusick became less optimistic about AT&T stock on Friday, largely because of the uncertainty surrounding the lead cable situation. Cusick knocked down its rating to "neutral" while lowering his price target on the stock from $22 to $17.
Cusick is worried that the liability from the leftover lead cables is impossible to predict and could act as a cloud over the stock for years. On top of that issue, the analyst expects the wireless business to slow further this year as competitors ramp up promotions, and he sees the fiber business gaining fewer new subscribers as well. Cusick called AT&T's free cash flow generation solid but sees a limited ability for the company to make meaningful progress in reducing its debt.
While these concerns are valid, AT&T's rock-bottom valuation offers investors a sizable margin of safety. Peak pessimism is often the best time to invest in a particular stock. The lead cable development weakens the investment thesis, but it doesn't derail it. AT&T stock still looks like a good value despite the risks.
