AT&T (T, Financial) is the second largest US telecommunications company. AT&T has a market cap of $183 billion versus $210 billion for slightly larger rival Verizon (VZ, Financial). AT&T has a long history of growth and has increased its dividend payments for 30 consecutive years. The company is one of the only dividend aristocrats with a dividend yield north of 5%. Learn more about AT&T’s future growth prospects and competitive advantage in part 39 of the Dividend Aristocrats In Focus series. The company’s business operations are analyzed below.
Business Overview
AT&T’s operations are divided into two primary segments: wireless and wireline. The wireless segment contributed 55% of revenue for the company through the first 3 quarters of fiscal 2014. The wireline segment contributed the remaining 45% of revenue.
The wireless segment includes revenue from both pre-paid and post-paid cell plans. The segment has grown revenue at about 5% through the first 3 quarters of 2014 versus the same period a year ago. AT&T’s future growth rests with growing cellular data usage and its wireless segment.
AT&T’s wireline segment sells internet, television, and voice over IP services to individuals. In addition, the company provides VPN, cloud, hosting, IP conferencing, Ethernet services and more to business and institutional customers.
Competitive Advantage
AT&T controls about 31% of the wireless market. Verizon controls another 34%, Sprint (S, Financial) controls 17%, and T-Mobile (TMUS, Financial) controls 10%. Together, these four companies make up about 92% of the wireless market in the US. AT&T has substantial pricing power because it operates in an oligopolistic industry with few competitors.
The wireless cellular data industry has so few players because there are significant up-front costs to starting and maintaining the infrastructure necessary for a wireless network. This barrier to entry dissuades new entrants to the market. In addition, wireless spectrum usage is controlled and auctioned by the US government. This further eliminates competition in the market and makes it virtually impossible for new entrants into the cellular data field. Not surprisingly, AT&T has spent more on lobbying than any other corporation over the last 15 years; nearly $59 million total.
The unique economics of the wireless industry reduce competition and allow AT&T to charge a premium price for its services. The company’s competitive advantage rests on its multi-billion dollar network it has built over the years combined with government restrictions. The company will likely maintain its strong competitive advantage and compete with Verizon for the top spot in wireless data for the foreseeable future.
Growth Prospects
AT&T’s future growth will come from growing consumer data usage and the company’s planned acquisition of DirecTV. The DirecTV acquisition will give AT&T a foothold in South America. In addition, the acquisition provides AT&T with a stronger bundled services package. AT&T is looking to expand its digital content distribution, and the DirecTV acquisition makes strategic sense in this light.
The company also has strong future growth in its wireless division. As part of an oligopoly, AT&T has strong pricing power. It will likely capture at least 30% of growth in wireless data usage and customers based on its current market cap. This is good news, as wireless data usage is expected to grow quickly over the next several years. AT&T charges its customers to access the wireless data so many people are addicted to today.
Despite strong tailwinds in wireless data, AT&T has not seen rapid growth over the last decade. The company has managed to grow revenue per share at just 4% a year. The company’s mediocre growth is due to declines in its legacy services in the wireline segment. The company is replacing lost sales in wireline with wireless growth. Going forward, AT&T will likely not grow revenue per share much faster than its historical growth rate even considering rapid smart phone data usage growth.
The company may be able to grow slightly faster than it has historically with the DirecTV acquisition. DirecTV has managed rapid revenue per share growth of over 20% a year over the last decade, though the company is expected to grow revenue per share at a about 10% a year going forward. AT&T may be able to deliver additional growth through bundling synergies in the US.
Dividend Analysis
AT&T has a current dividend yield of 5.2% which should appeal to investors seeking current income. The company has a payout ratio of 70% of expected full year 2014 earnings. AT&T will only be able to grow its dividend payments in line with overall company growth due to its high payout ratio. As a result, shareholders should expect a dividend growth rate of around 4% to 5% going forward.
Valuation
AT&T currently trades at a P/E ratio of just 13.7 times expected 2014 EPS. The S&P 500 currently trades at a P/E ratio of 19.7. AT&T looks like a bargain at current prices compared to the S&P 500. Historically, AT&T has traded at a discount of about 0.8x to the S&P 500’s P/E ratio. At current market prices, AT&T should be trading for a P/E ratio of about 15.8. Based on its historical P/E ratio relative to the S&P 500, I believe AT&T to be undervalued at this time.
Recession Performance
AT&T locks its customers into multi-year contracts that typically come with substantial cancellation fees. As a result, it is somewhat insulated from the effects of recessions as customers experience substantial switching costs. AT&T saw small declines in revenue per share during the Great Recession of 2007 to 2009. The company also saw its EPS fall from 2007 highs; the company has still not returned to EPS levels from 2007. AT&T’s EPS from the start of the Great Recession to now are shown below:
- 2007 EPS of $2.76 (all time high)
- 2008 EPS of $2.16
- 2009 EPS of $2.12 (recession low)
- 2010 EPS of $2.29
- 2011 EPS of $2.20
- 2012 EPS of $2.33
- 2013 EPS of $2.50
- 2014 EPS of $2.60 (includes estimate of Q4 EPS)
Final Thoughts
AT&T is a solid investment for investors seeking current income. The company has mediocre growth prospects going forward with the caveat that the DirecTV acquisition may boost growth if significant synergies are realized. The company is ranked in the Top 25 based on The 8 Rules of Dividend Investing due to the stock’s high dividend yield of 5.2% and fairly low price standard deviation of 22%. Overall, the company makes a solid to an income oriented investor’s portfolio.
