After enduring a wrenching stock market downturn, investors have once again started turning to the security and tangibility of dividends. Not surprisingly, that's meant a lot of attention for telecom providers since their stocks feature some of the market's fattest payouts. CenturyLink (NYSE: CTL) pays 6.6% while Verizon (NYSE: VZ) and AT&T (NYSE: T) both offer up 5.9%.
But while AT&T's dividend is juicier than a perfectly ripe Florida orange, is the stock worth buying? Let's take a closer look.
It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how AT&T stacks up.
|
Company |
Total Enterprise Value / Trailing Revenue |
Price / Forward Earnings |
Total Enterprise Value / EBITDA |
Price / Book Value |
|---|---|---|---|---|
| AT&T | 1.9 | 11.9 | 5.5 | 1.5 |
| CenturyLink | 2.9 | 13.8 | 5.6 | 1.4 |
| Leap Wireless (Nasdaq: LEAP) | 1.3 | NM | 6.1 | 0.8 |
| MetroPCS (NYSE: PCS) | 1.8 | 14.4 | 6.5 | 1.8 |
| Sprint Nextel (NYSE: S) | 0.9 | NM | 5.9 | 0.8 |
| Verizon | 1.8 | 15 | 5.3 | 2.5 |
| Windstream (Nasdaq: WIN) | 3.8 | 16.9 | 7.8 | NM |
| Average* | 2.1 | 15 | 6.2 | 1.5 |
Source: Capital IQ (a Standard & Poor's company) and Yahoo! Finance.
*Average excludes AT&T.
NM = Not meaningful.
Using each of those averages to back into a stock price for AT&T, and then taking the average across those results, we can come up with an estimated price per share of roughly $32. This would suggest today's price just shy of $29 is somewhat undervalued.
A comparable company analysis like this can sometimes raise as many questions as it answers, though. For instance, is the entire group properly valued? A supposedly fairly valued -- or even overvalued -- stock among a bunch of other undervalued stocks may actually be an undervalued stock, and vice versa.
Also, while these businesses are comparable to AT&T, none is a perfect match. CenturyLink and Windstream both focus primarily on land-line communications. Leap and MetroPCS are both wireless carriers, but are much smaller up-and-coming players. Sprint Nextel has a pretty comparable business, but its struggles make it more of a turnaround story than a blue-chip performer. And while Verizon is a very similar business, the details still aren't quite the same, including (at least for now) a very key AT&T differentiator -- the Apple iPhone.
With all that in mind, it's best to combine comparable company analysis with another valuation technique.
Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow (DCF). Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).
Because a DCF is based largely on estimates (aka guesses) and it attempts to predict the future, it can be a fickle beast and so its results are best used as guideposts rather than written-in-stone answers sent down from Mount Olympus.
For AT&T's DCF, I used the following assumptions:
| 2010 Unlevered Free Cash Flow | $15.5 billion |
| FCF Growth 2010-2014 | 6.4% |
| FCF Growth 2014-2019 | 3.2% |
| Terminal Growth | 3.0% |
| Market Equity as a Percentage of Total Capitalization | 71.0% |
| Cost of Equity | 12.0% |
| Cost of Debt | 6.2% |
| Weighted Average Cost of Capital | 9.8% |
Source: Capital IQ (a Standard & Poor's company), Yahoo! Finance, author's estimates.
While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers I tend to thumb my nose at.
But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.
Based on the assumptions above, a simple DCF model spits out a per-share value of roughly $36 for AT&T's stock. This seems to confirm that the stock is currently undervalued.
Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well-advised to play with the numbers further before making a final decision on AT&T's stock.
That said, pegging the price right between the two valuation models -- which gives us $34 -- it would seem that we've got a margin of safety pretty close to 20%. Combine that apparent cheap price with the stock's healthy dividend payout and AT&T starts to look like a pretty good buy.
But I'd be remiss not to mention the very obvious risk to AT&T's results. The company hasn't exactly wowed its customers -- a recent Consumer Reports survey ranked AT&T dead last among U.S. mobile service providers -- but it's been able to avoid massive subscriber defections by having the one thing no other carrier has: the iPhone. That won't last forever, though, and it's anybody's guess how AT&T will absorb that blow.
I've got my money where my mouth is on this one, as I own AT&T shares in my personal portfolio. Anecdotally, I've been a very satisfied AT&T subscriber (after many dreadful years with Sprint). And though customers may not be raving to Consumer Reports about AT&T's service, they're also not ranting to the Better Business Bureau about the company. Of the four largest U.S. wireless carriers, AT&T received the fewest BBB complaints over the past year.
AT&T may not be the most exciting stock out there, but with a reasonable price tag and a healthy dividend, I'm content continuing to dial it up in my portfolio.
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