AT&T (T) and Verizon (VZ) are the two biggest telecommunications companies in the U.S. The two behemoths have always enjoyed excessive free cash flows thanks to their dominant position in their business and the high barriers to entry to potential competitors.
As a result, they have always offered generous dividends and hence they are interesting candidates for the portfolios of income-oriented investors.
Let's compare the prospects of these two telecommunications giants.
AT&T is a diversified, global leader in telecommunications, serving more than 100 million customers. Almost a year ago, AT&T completed the spinoff of WarnerMedia.
AT&T is a colossal business, which generates approximately $120 billion of annual revenues. However, it has grown its earnings per share by only 0.3% per year on average over the last decade. As a result, the stock has dramatically underperformed the broader market over the last decade, declining 33% whereas the S&P 500 has rallied 150%.
The poor performance of AT&T has resulted primarily from some poor major investing decisions. AT&T acquired DirecTV for $65 billion in 2015, close to the peak of the business of the acquired company. After having lost about 10 million subscribers, AT&T spun off DirecTV, with an implied enterprise value of only $16.25 billion. A similar situation was evidenced with Time Warner, which AT&T acquired in 2018 but spun off last year. In both situations, AT&T bought high and sold low, thus impairing its shareholder returns.
On the bright side, now that these poor investing moves belong to the past, AT&T has become a leaner company, which has become more focused on its strong divisions. The latest results of the company reveal strong business momentum and signal that the future of the company will probably be better than the last decade.
In the fourth quarter of 2022, AT&T grew its revenue 1% over the prior year's quarter thanks to strong customer additions across its growing 5G wireless and fiber networks. The company is investing in the expansion of its 5G and fiber networks at a record pace. It posted 280,000 fiber net additions and thus it has posted more than 200,000 additions per quarter for 12 consecutive quarters.
It also posted 656,000 postpaid phone net additions. Moreover, it grew its wireless revenues by 5.2% and its consumer broadband revenues by 7.2%. As a result, it grew its adjusted EPS 9%, from $0.56 to $0.61, and thus exceeded the analysts' estimates by $0.04. AT&T has exceeded the analysts' estimates for 9 consecutive quarters.
On the one hand, management provided lackluster guidance for EPS of $2.35-$2.45 in 2023, implying a 7% decrease at the mid-point. On the other hand, management has proved somewhat conservative in its guidance in recent quarters. Given also the strong business momentum of AT&T, it is reasonable to expect the company to meet or exceed the upper limit of its guidance.
Moreover, a significant growth driver for AT&T will be the reduction of debt. Due to the huge acquisitions of the past, AT&T has accumulated an excessive debt load. Its net debt currently stands at $277 billion, which is more than double the current market capitalization of the stock. It is also remarkable that annual interest expense has nearly doubled in the last eight years, from $3.5 billion to $6.1 billion.
Due to its high debt load, AT&T has stated that it will use its excessive free cash flows to reduce its debt load in the upcoming years. In this way, the company will reduce its interest expense and hence it will provide a boost to its EPS. AT&T has stated that it expects to grow its revenues at a low-single-digit rate and its EPS at a mid-single-digit rate. Nevertheless, we find it prudent to expect annual growth of EPS around 2% in order to be on the safe side, given the poor performance record of the company.
Verizon, which was created by the merger of Bell Atlantic with GTE in 2000, is one of the largest wireless carriers in the country. Wireless generates three-quarters of the total revenues of the company while broadband and cable services account for about a quarter of sales. The network of Verizon covers approximately 300 million people and 98% of the U.S.
A key competitive advantage of Verizon is its reputation as the best wireless carrier in the U.S. This is clearly reflected in the wireless net additions of the company and its exceptionally low churn rate. This reliable service allows Verizon to maintain its customer base and move some customers to higher-priced plans.
Verizon has avoided the investment seesaws of AT&T but it has exhibited a lackluster performance record over the last decade as well. During this period, Verizon has grown its EPS by just 2.6% per year on average. Due to its disappointing business performance, the stock has dramatically underperformed the S&P 500 over the last decade (-24% vs. +150%).
Moreover, Verizon exhibits uninspiring business momentum right now. In 2022, it posted essentially flat sales and saw its EPS dip 6% due to high operating expenses as well as high interest expense. Management has provided guidance for EPS of $4.55-$4.85 this year, implying a further 7% decrease this year.
Verizon expects to grow its revenues in the future thanks to its high-quality network and meaningful subscriber growth in its fixed wireless business. However, as the whole telecommunications industry in the U.S. is expected to grow by only 0.5% per year, it is prudent to be conservative in future growth expectations, particularly given the lackluster record of the company.
Overall, both AT&T and Verizon are likely to grow their EPS at a low-single-digit average annual rate in the upcoming years. AT&T is more likely to surprise on the upside thanks to its recent divestments and the resultant increased focus on its promising segments.
AT&T raised its dividend for 36 consecutive years but it froze its payout for eight consecutive quarters, from the beginning of 2020 to the end of 2021. As a result, the company was removed from the group of Dividend Aristocrats. Moreover, after the spinoff of WarnerMedia, AT&T reduced its dividend by 47%, as the new company is much smaller than the previous one. Verizon has raised its dividend for 18 consecutive years.
Verizon is currently offering a nearly 10-year high dividend yield of 7.1%. This yield is higher than the 6.1% dividend yield of AT&T. This is remarkable, as Verizon has offered a lower dividend yield than AT&T throughout most of the last decade. However, it is important to note that Verizon has a higher payout ratio than AT&T (56% vs. 44%). In fact, the current payout ratio of AT&T is a 10-year low for the stock.
As both companies have proved resilient to recessions and have healthy payout ratios, their dividends should be considered safe. On the other hand, investors should not expect meaningful dividend growth going forward. AT&T recently cut its dividend while Verizon has grown its dividend by just 2.1% per year on average over the last five years.
Overall, Verizon is offering a higher current dividend yield but AT&T has a lower payout ratio and stronger business momentum. Therefore, it is likely to raise its dividend somewhat faster than Verizon in the upcoming years.
AT&T is currently trading at a nearly 10-year low price-to-earnings ratio of 7.3, which is much lower than the 10-year average of 11.2 of the stock. Due to the disappointing performance record of the company and the uncertainty related to the transformation of the company, we assume a fair earnings multiple of 10.0 for the stock. If AT&T trades at a P/E ratio of 10.0 in five years, it will enjoy a 6.5% annualized valuation tailwind.
Verizon is currently trading at a nearly 10-year low price-to-earnings ratio of 7.9, which is much lower than the five-year average P/E ratio of 11.0 of the stock. The exceptionally cheap valuation has resulted from the poor business momentum but also from high inflation, which greatly reduces the present value of future earnings. Thanks to the aggressive policy of the Fed, we expect inflation to subside in the upcoming years and thus we expect Verizon to revert to its average valuation level. If Verizon trades at a P/E ratio of 11.0 in five years, it will enjoy a 6.8% annualized valuation tailwind.
Overall, both AT&T and Verizon are remarkably cheaply valued right now, with neither of the two stocks having a clear valuation advantage over the other. Thanks to their cheap valuation levels, both stocks are likely to highly reward patient investors in the upcoming years. The reversion of inflation to healthy levels and potential business improvement are strong potential catalysts for both stocks.
Verizon and AT&T have both underperformed the broader market dramatically over the last decade, primarily due to their disappointing business performance throughout this period. In addition, both stocks are currently trading at nearly 10-year low P/E ratios, primarily due to high inflation.
AT&T is offering a 6.1% dividend yield, which is lower than the 7.1% yield of Verizon. AT&T has hurt its shareholders with its poor investment decisions in the last seven years. However, we expect the company to significantly improve its performance now that it has become laser focused on its core business.
Given also the lower payout ratio of AT&T, we find AT&T somewhat more attractive than Verizon right now. With that said, thanks to their exceptionally cheap valuation levels, both stocks are likely to highly reward those who purchase them around their current prices.