Is AT&T Going the Direction of GE?
GE’s stock performance struggles have been rightfully advertised over the last couple of years as the stock has fallen from over $30/share at the beginning of 2017 to as low as $6.40/share last year. The stock was hit hard as valuations were too expensive, the overall business lacked a uniform sense of direction, a complicated balance sheet led to heavy indebtedness, and a massive dividend cut drove income investors from the stock.
The writing was on the wall for GE many months before the ensuing decline, but investors wanted to give the company a pass because of the blue-chip reputation, the longevity of the business, and a feeling, for many, that the stock was part of their family legacy. I always warn people of holding stocks that are passed down to them by previous generations, as businesses can drastically change over time.
Another company that may warrant many similar concerns is AT&T (T). Like GE, AT&T has been around for many years and has been passed down for many generations. One difference between the two companies is the valuation measures. Several years ago, I thought that GE became too expensive around $28/share due to its elevated valuations, and I recommended a sell at that time. This is not currently the story for AT&T as its valuations look quite appealing. The current P/E of 11.5 is below the industry average of 24.8, Price/Sales of 1.3 is lower than the industry average of 1.6, and Price/Cash Flow of 4.7 is inexpensive compared to the industry average of 6.3. If I look at earnings on a forward basis, December 2020 GAAP EPS of $2.73 would produce a forward multiple of 11.7. As a reminder, my firm sells companies when they hit the market’s 40-year average for the forward P/E of 16.5, so a valuation of 11.7 remains attractive.
A concern that reminds me of the GE situation for AT&T is the direction the business is heading. GE had a few core businesses, but as it reached for growth it dove into new business ventures that were costly and did not add value to its core businesses. AT&T has made some questionable acquisitions over the last few years that make me question the direction of the company. The wireless phone business makes up about 40% of AT&T’s total revenue and, more importantly, about 60% of the company’s total operating income. The company is trying to diversify away from its reliability on this segment of the business with recent acquisitions of DirecTV and Time Warner. While I like many of the assets that came with the Time Warner deal, I am not seeing the big benefit for the company. I am concerned that focusing on content, streaming, and other businesses will cost AT&T time that could be spent developing its network which Verizon has been heavily investing in. In the long run, if Verizon’s network becomes superior, I’m concerned it could cost AT&T customers which could hurt the major cash cow it has in its business.
The major acquisitions have also cost large amounts which have weakened the balance sheet. The DirecTV deal had a transaction value of $65.7 billion in July 2015 and the Time Warner deal has a transaction value of $106.3 billion in June 2018. These major acquisitions have driven the company’s debt from $81.8 billion at the end of 2014 to over $176 billion at the end of 2018. It has also caused Goodwill and Intangible Assets to increase from $136.7 billion at the end of 2014 to over $310 billion at the end of 2018. For reference, the company’s current total equity is $184 billion. This means if the company faces large write downs due to overpaying for these major assets, it’s total equity could see a major decline. DirecTV has so far provided some major questions as the business unit it is a part of saw its sales fall 7.1% in 2018. The Time Warner deal is still too fresh to realize any value, but I am concerned the war over content against companies like Disney, Netflix, and Apple could come with an expensive price tag.
Like GE, many investors have relied on AT&T’s dividend as an income source. The current yield of 6.4% is quite appealing, but like GE, the dividend payout ratio is starting to creep up. The current payout ratio of 75.7% is not in an emergency state, but large debt repayments could cause the company problems with cash flow. AT&T has said its dividend is extremely safe but based on the numbers, I would be cautious on relying on it for many years to come.
Overall, the numbers and the story for AT&T look far better than they did for GE. With that said, I would be extremely cautious with the company given the heavy debt load and an immense amount of intangible assets. It is for these reasons that even though the valuations look appealing, I would not recommend holding the stock.