The trouble with AT&T


I’ll be blunt: I hate AT&T.

I’m not referring to AT&T’s mobile phone service or home internet service (both of which I dumped years ago for being overpriced).

I’m talking about AT&T stock (T). Though to be fair, I’m not any more fond of Verizon (VZ), Vodafone (VOD) or any of the other large telecom stocks.

 

 

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Mama Bell

Given that I recommend high-yield stocks, you might assume that high-yielding telcos like AT&T – especially with its merger with Time Warner (slowly) pushing forward – would be right up my alley.

AT&T sports a dividend yield of 6.1%, making it one of the highest-yielding stocks in the S&P 500. It’s also raised its dividend for 34 consecutive years and counting. That’s not a bad run.

So, if it pays a nice dividend and has a history of raising it… what’s not to like?

 

 

No Moats

Well, to start, in my view AT&T has nothing in the way of competitive moats. You can change mobile carriers in a matter of minutes now, and contracts are less of an impediment to leaving than they were in the past. Led by T-Mobile, virtually every carrier now advertises no-contract plans.

Is AT&T future proof? Not exactly in my opinion.

Much of AT&T’s infrastructure consists of legacy copper wiring originally used for landline phones, and the company constantly is upgrading its mobile network to stay competitive. AT&T is stuck on a technology treadmill, and it has to keep running… or risk getting thrown off.

 

Demand Dynamics

But isn’t demand for its services rising, at least?

Yes and no.

Yes, we all use more data today than we did a few years ago, and that trend isn’t likely to reverse any time soon.

But the smartphone market is now saturated in every developed country and not far from saturation in many emerging markets. So, while demand for service (particularly data) is growing, that growth is not leading to higher revenues or profits. And that’s just mobile data.

Home internet is a saturated market, and paid TV is actually shrinking due to cord cutting. So, it appears to me that all of AT&T’s businesses are mature, no-growth businesses at this point.

 

Dividends?

AT&T’s dividend payout ratio looks low, at 40%. But this headline number, in my opinion, misses the fact that net income was inflated last year due to corporate tax cuts passed in December.

AT&T realized a $20 billion extraordinary tax benefit, which I expect will not be repeated.

Between 2014 and 2016, the payout ratio averaged 107%, meaning the company paid out more than it was earning.

Lower tax rates going forward will help, of course. But in the first quarter of this year, the payout ratio was 67%.

That’s not a range that puts the company at immediate risk of cutting the dividend, of course.

 

Cash Flow

But in order for AT&T to safely raise it from here, they need growth. And free cash flow has barely budged over the past decade.

AT&T changed its business model by merging with content creator Time Warner, the parent of HBO, CNN and a host of other networks.

But given the glut of content these days and the unrelenting competition from Netflix (NFLX), Amazon (AMZN), and other up-and-coming creators, it’s hard for me to see this being the growth vehicle AT&T needs.

And all of this assumes the government doesn’t torpedo the deal, which it has indicated it intends to do.

Bottom line, don’t expect to see AT&T in my Peak Income portfolio any time soon. I believe we can do better.


This piece first appeared on The Rich Investor.

Photo Credit: Mike Mozart via Flickr Creative Commons

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Charles Sizemore
Charles Sizemore
Sizemore Capital Management LLC is a registered investment advisory firm located in Dallas, Texas. Charles Lewis Sizemore, CFA is the founder and Chief Investment Officer of the firm.