The telecommunications sector came under pressure last week, on reports that the major companies are at risk of lawsuits due to lead cables. The selloff caused shares of AT&T Inc. (T) to hit 30-year lows, while Verizon Communications (VZ) fell to a 10-year low.
Litigation risk should not be overlooked, but the selloff appears overdone. Both AT&T and Verizon stock continue to generate strong cash flow, with leading positions in their respective industries.
In the meantime, the stocks have high dividend yields and appear to be undervalued after the recent selloff.
AT&T
The company serves over 100 million customers and generated $121 billion in revenue in 2022. Its financial results have improved as the company's turnaround efforts take hold. The company grew its first-quarter revenue 1% over the prior year's quarter thanks to strong customer additions across its growing 5G wireless and fiber networks. AT&T has beaten the analysts' estimates for 10 consecutive quarters.
In 2022, AT&T completed the spin-off of WarnerMedia to form the new company Warner Bros. Discovery (WBD) . AT&T shareholders received 0.241917 shares of WBD for every one share of AT&T they held. With the WarnerMedia spin off complete, AT&T is focusing on its core business of communications.
AT&T is investing in the expansion of its 5G and fiber networks at a record pace to generate growth. AT&T posted 272,000 fiber net additions and thus it has posted more than 200,000 additions per quarter for 13 consecutive quarters. It also posted 424,000 postpaid phone net additions. However, adjusted earnings-per-share slipped -5%, from $0.63 to $0.60, and free cash flow missed the analysts' consensus by a wide margin ($1.0 billion vs. $3.0 billion) due to excessive investments.
For its part, AT&T released a statement saying less than 10% of its copper-wire network has lead-encased cables. Therefore, it appears its exposure is manageable. The company expects free cash flow to improve in the second half of the year and has provided guidance for adjusted earnings-per-share of $2.35-$2.45 in 2023. As a result, the company should cover its dividend, which currently yields 7.5%.
AT&T has been a colossal business, easily generating profits of approximately $20 billion per year. Now the company is focusing on its roots and has growth opportunities in the way of building out its 5G and fiber networks. We expect AT&T to grow its earnings-per-share at a 2% average annual rate over the next five years.
The selloff in AT&T shares appears overdone. With expected adjusted EPS of $2.40 for 2023, AT&T stock now trades for a P/E ratio of 6.2. AT&T has traded at an average price-to-earnings ratio of 11.2 over the last decade. We view AT&T as undervalued, with a fair value P/E of 10. As a result, estimated returns for AT&T of 18% per year, based on returns from an expanding valuation multiple, EPS growth, and dividends.
Verizon Communications
Verizon is one of the largest wireless carriers in the country. Wireless contributes three-quarters of all revenues, and broadband and cable services account for about a quarter of sales. The company's network covers ~300 million people and 98% of the U.S.
On April 25th, 2023, Verizon announced earnings results for the first quarter for the period ending March 31st, 2023. For the quarter, revenue decreased 1.9% to $32.9 billion, which was $712 million below estimates. Adjusted earnings-per-share of $1.20 compared unfavorably to $1.35 in the prior year, but was $0.01 higher than expected. Verizon had postpaid phone net losses of 127K during the quarter, but retail postpaid net additions totaled 633K. Revenue for the Consumer segment declined 1.7% to $24.9 billion as gains in service and other revenue was more than offset by lower equipment sales.
Broadband continues to act well as the company added 437K net new customers during the period, the best result in more than a decade. This included 393K fixed wireless net additions. Fios additions totaled 63K. Retail connections totaled 143 million and the wireless retail postpaid phone churn rate was low at 0.90%. Free cash flow more than doubled to $2.3 billion from $1 billion in the prior year.
Verizon reaffirmed guidance for 2023 as well with the company still expecting adjusted earnings-per-share of $4.55 to $4.85 for the year. Wireless service revenue is still projected to grow 2.5% to 4.5%.
We view Verizon as a strong dividend stock. In September 2022, Verizon announced that it was increasing its quarterly dividend 2% to $0.6525. The company has a dividend growth streak of 18 consecutive years.
VZ stock currently yields 7.7%. Verizon's shareholders are receiving a yield that is more than four times that of the S&P 500 index and the payout ratio is expected to be roughly 56% for this year. Verizon's dividend should continue to grow at a similar rate to that of its historical average.
Based off of the current share price and the midpoint of earnings guidance for 2023, Verizon has a forward P/E of 7.2. We reaffirm our target P/E of 11, leaving potential for significant returns from an expanding multiple. In addition to EPS growth and dividends, we estimate total returns at 16.7% per year over the next five years.
