Over the last five days, two investment firms upgraded AT&T (T) to a buy/overweight, plus Barron's named the stock to its top picks for 2022. The shares, down about 15% year to date, have been out of favor after announcing the sale of WarnerMedia to Discovery (DISCA) combined with a dividend cut. So, after a lousy year, it's worth looking at the fundamental case.
The investment case for AT&T hinges on an attractive risk/reward profile starting at a historically low valuation.
The Fundamental Case
AT&T has solid business fundamentals and earnings visibility. The core business has been performing well; wireless service revenues grew just under 5% last quarter, coupled with postpaid customer adds that topped the industry. The consumer wireline business has started to improve, led by growth in fiber additions, offsetting the secular decline in business wireline.
Wall Street assumes a meaningful growth deceleration in the wireless industry, yet Morgan Stanley notes in its upgrade that the stock's low valuation seems to overly discount next year's slowing business trends and competitive pressure.
The primary catalyst by mid-2022 is the closing of the WarnerMedia deal with Discovery. Two separate companies, focused and investing entirely in their core competencies, will likely be more appreciated by investors.
Warner has benefited from strength at HBO Max with a global rollout underway, giving momentum before the handoff to Discovery. Although the final structure of the deal has not been announced -- whether a share exchange or a spinoff -- AT&T shareholders will own 71% of the new Warner Bros Discovery with the remaining 29% owned by current Discovery holders. AT&T will also receive $43 billion in cash, expected to deleverage the balance sheet. By 2024, total debt may be significantly reduced to $122 billion from $179 billion.
Post deal, the slimmed-down AT&T guided to paying out around $8 billion-$9 billion annually in dividends -- likely equating to a dividend yield in the 5.5% to 6.5% range -- significant reduction from the current 8.5% but still one of the highest yields in the S&P 500.
Morgan Stanley expects earnings around $2.50 per share and growing in the mid-single-digits through 2024. AT&T may opt for a deal structure with a share exchange, which would reduce the shares outstanding by up to 20%. The EPS calculation would be adjusted accordingly and still reflect a P/E under 10.
Undoubtedly, AT&T has given investors cause for distrust after management overpaid for several acquisitions that far underperformed expectations. This year, AT&T received $7.1 billion from TPG for a 30% stake in DirectTV for which it had laid out $67 billion including debt in 2015. The Time Warner deal, an $85 billion deal, will only break even for T holders if Discovery doubles in value. The only return shareholders did see from these deals was some dividend cash flow.
One other cause for concern stems from complaints from the aviation industry and the FAA about the use of 5G airwaves interfering with aircraft electronics. The wireless industry has pushed back noting that 5G C-Band spectrum is currently used safely in over 35 countries. Potential workarounds for aviation are in the works.
Fitting the Mold
2022 promises to be a choppy year, with pundits predicting value outperforming growth. Mike Wilson, equity strategist from Morgan Stanley, sees the combination of Fed tightening and slowing economic growth leading to investor defensiveness with a pivot from growth to value. He favors large-cap defensive quality. AT&T fits this mold, especially after significantly underperforming this year. The shares have a low P/E ratio and a high dividend yield that is well covered by cash flow.
For new investors there will be a cushion before the deal with Discovery closes, three dividend payments amounting to $1.56, about a 6.5% gain over the next seven months.
AT&T may not be an exciting stock but it presents as a boring value investment with a catalyst for above-market returns in 2022.