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3 Green Flags for AT&T's Future

AT&T (NYSE: T) was once considered a stable stock for long-term investors, but it lost more than a third of its value over the past five years. That decline can be attributed to competitive headwinds in the wireless market, the slow death of its pay-TV business, its debt-fueled acquisitions of DirecTV and Time Warner to offset that secular decline, and its costly 11th-hour attempts to build a streaming media ecosystem to counter the cord-cutting trend.

The pandemic exacerbated that pain by disrupting WarnerMedia's theatrical releases and its production of new content. All those headwinds made it tough to invest in AT&T, even as its price-to-earnings ratio dropped to the single digits and its dividend yield hit an all-time high.

Image source: AT&T.

But has the market been too obsessed with AT&T's weaknesses and paid too little attention to its strengths? Let's take a look at three green flags for the telecom and media giant's future to see if it's becoming a value play.

1. Reducing its leverage

AT&T's biggest mistake over the past decade was its debt-fueled "diworsification." Instead of improving its core wireless business, it acquired too many other companies to build a massive media business that had too many silos and incompatible moving parts. As a result, its long-term debt rose at a much faster rate than its total revenue.

Source: YCharts

AT&T ended last quarter with $155.4 billion in long-term debt. However, it expects its net debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio to gradually decline from a "peak" of 3.1 at the beginning of 2021 to less than 2.5 by the end of 2023.

It's reducing its leverage with big divestments and spin-offs. It recently spun off DirecTV (but retained a 70% stake in the new company) and divested its Latin American satellite unit Vrio, the mobile gaming publisher Playdemic, the tabloid media site TMZ, the anime platform Crunchyroll, and other non-core assets. It also sold some of its real estate.

The biggest spin-off of all will occur in mid-2022 when AT&T merges WarnerMedia's assets with Discovery (NASDAQ: DISCA) (NASDAQ: DISCK) to create a new media company. AT&T's investors will receive new shares of the spin-off, while the "new" AT&T will reduce its dividend to reflect that divestment -- which should free up even more cash to reduce its debt and expand its 5G networks.

2. Stable growth ahead

After the spin-off, AT&T expects to grow its annual revenue at a low-single-digit compound annual growth rate (CAGR) from 2022 to 2024, and for its adjusted EBITDA and adjusted EPS to both rise at a mid-single-digit CAGR.

AT&T expects to pay out 40%-43% of its estimated free cash flow (FCF) of at least $20 billion as dividends in 2023. That estimate implies its forward dividend yield will decline from nearly 8% today to about 6%.

That dividend cut might seem like a setback, but we should remember that reinvesting AT&T's massive dividend yield failed to give the stock a positive total return over the past five years. Therefore, that cash would arguably be better spent on improving its core wireless business to boost its revenue.

Source: YCharts.

Several major analysts believe the new AT&T will fulfill its promises. Last month, Morgan Stanley analyst Simon Flannery upgraded the stock to "overweight" and predicted the streamlined company would be a "much clearer and focused communications business."

Earlier this month, Wells Fargo analyst Eric Luebchow upgraded AT&T to "equal weight" and said that even though it faced near-term challenges, he saw a "pathway" for the company to generate over 5% annual EPS growth and more than 10% FCF growth through 2025.

We should take these analysts' expectations with a grain of salt, but they suggest that the market is still underestimating AT&T's turnaround potential.

3. Inflation could generate tailwinds

Rising inflation and higher interest rates have crushed many high-growth tech stocks over the past few months. However, those macroeconomic headwinds could actually become tailwinds for AT&T as rattled investors rotate back toward cheap blue-chip tech stocks with high dividends.

AT&T will still face an uphill battle this year, but its forward price-to-earnings ratio of seven should limit its downside potential. Verizon (NYSE: VZ), which could be another safe haven stock in an inflationary market, trades at nine times forward earnings.

Even if AT&T reduces its forward yield to about 6% after the WarnerMedia spin-off, it would still be much higher than the 10-Year Treasury's 1.7% yield, as well as Verizon's forward yield of 4.8%. That attractive yield, along with its low valuation and clearer plans for the future, could make it an appealing stock for income investors again.

Keep an eye out for a rebound

AT&T isn't a screaming buy yet, but it might fare better than other battered high-growth stocks this year. Therefore, investors should keep this stock in mind while hunting for safe-haven stocks in this wobbly market.

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Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Leo Sun owns AT&T. The Motley Fool recommends Discovery (C shares) and Verizon Communications. The Motley Fool has a disclosure policy.


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