The stock market has rendered its verdict on AT&T (T 1.02%) stock this year. While the S&P 500 is up around 10% year-to-date, shares of the telecom giant have tumbled roughly 20%.
There are some good reasons for the pessimism. The wireless industry has slowed this year, partly a hangover following a period of strong pandemic-era growth, and partly the result of an uncertain economic environment. AT&T still added just over 300,000 net postpaid phone subscribers during the second quarter, but that's less than half what it was adding each quarter throughout much of 2021 and 2022.
With AT&T stock trailing the broader market by such a wide margin while the wireless industry is becoming more competitive, it's understandable that many investors have written off the telecom giant entirely. But there's one good reason to seriously consider the stock.
A historically beaten-down valuation
A company's growth prospects are only one-half of the equation. It's true that AT&T is likely facing a slower growth environment in the years ahead compared to the past few years. Consumers are keeping their smartphones for longer, creating fewer opportunities for AT&T to win over customers from rivals and convince existing subscribers to upgrade plans. The global smartphone replacement cycle has surpassed 40 months, according to Strategy Analytics, up from less than 30 months a decade ago.
There are some bright spots for AT&T, particularly the fiber internet business. The company is building out its fiber network in existing service areas, and it's tapping a joint venture with BlackRock to offer fiber service outside of those areas. AT&T now has 7.7 million consumer fiber subscribers and has passed just over 20 million consumer locations with its fiber network. The plan is to reach 30 million consumer and business locations by 2025.
The second half of the equation is valuation. On every measure, AT&T stock appears incredibly inexpensive. Based on the average analyst estimate for this year, AT&T sports a price-to-earnings ratio of just 6.1. Based on the company's guidance for full-year free cash flow of at least $16 billion, the stock's price-to-free-cash-flow ratio sits at about 6.6. For comparison, the S&P 500 currently trades for 24 times earnings, and its long-term median is approximately 15.
Given AT&T's slow-growing nature and the potential for profits to be squeezed as the wireless industry becomes more competitive, the stock certainly doesn't deserve to trade at a premium to the broader market. But it doesn't deserve to trade at a massive discount, either.
Even if AT&T stock doesn't earn a richer valuation anytime soon, a generous dividend that currently yields about 7.5% will reward patient investors as they hold the stock. AT&T's dividend looks sustainable, set to eat up just 50% of free cash flow this year. With a rock-bottom valuation and sustainable high-yield dividend, AT&T stock can be a long-term winner even if the business itself keeps trudging along.
But keep an eye on the debt
Outside of competitive pressure, there's one thing that AT&T investors should be concerned about: Debt. Telecom companies tend to carry a lot of debt on their balance sheet, borrowing heavily to fund infrastructure buildouts and spectrum purchases. AT&T took this a step further and funded some of its media buying spree with debt. Even with those media businesses largely gone, some of that debt remains.
AT&T had $143 billion of debt at the end of the second quarter. The company shelled out $1.6 billion for interest in that quarter alone. About 25% of AT&T's operating income was eaten up by interest payments.
AT&T is working to reduce this debt over the next few years, and it's not a huge problem right now. But with interest rates rising, as AT&T refinances debt down the road, the company is almost certainly going to be hit with higher interest rates. AT&T's debt maturities are spread out over time – $8.95 billion of maturities in 2025 will be the highest annual total through 2027. But with weighted average interest rates ranging from 3.1% to 5.5% on the debt maturing over the next five years, AT&T's interest expense could rise even as the company reduces its debt load.
Higher interest payments could offset sources of free cash flow growth and make it difficult for the company to grow the bottom line. That could be enough to keep the stock trading at a depressed level, and in the worst-case scenario, it could eventually put pressure on the dividend.
I'm an AT&T shareholder, so I obviously think this risk is outweighed by the positives. But it's not unreasonable to avoid AT&T stock because of the high level of debt.
