There are times in the markets when valuation of a particular stock defies logic. It can be in a phase of euphoria or in a bear market for the stock. A classic example seems like AT&T (NYSE:T). T stock has been in a long-term downtrend and currently trades just above $23.50.
Of course, the correction in T stock is due to fundamental factors. In particular, leverage and growth concerns. However, my point is that selling is overdone.
First and foremost, T stock currently trades at a forward price-to-earnings-ratio of 7.6. With the S&P 500 index trading at a cyclically adjusted P/E ratio of 37.8, the relative valuation seems attractive.
Furthermore, 20 analysts have a median price target of $29 on the shares. This would imply 22% upside potential from current levels.
Clearly, the selling seems to be overdone. With several positive catalysts, T stock is poised for a reversal rally.
It’s worth mentioning here that AT&T stock has a current dividend yield of 8.7%. Post the spin-off of the media division, the company plans a significant dividend cut. This is another reason for the stock remaining depressed. However, this news has been in the market for the last few quarters. It’s therefore discounted in the valuation.
Positive Catalysts for T Stock
A major advantage of the spin-off is that AT&T will be a leaner organization. Chief Executive John Stankey believes that the company will emerge with “a much more crisp and intense focus.” This is likely to create value. As a matter of fact, the company has already been delivering steady growth in the mobility division.
In terms of specific segments, 5G is likely to be a game-changer. AT&T has already made significant investments in the next-generation mobile business. Further, the company plans to reach 30 million customers by 2025. On an annual basis, AT&T is targeting a capital expenditure of $24 billion for its 5G and fiber broadband business.
The last year has already been encouraging for the mobility business. AT&T added 3.2 million post-paid phone customers. Additionally, one million fiber subscribers were added.
Another important point to note is that AT&T reported revenue of $30.2 billion from the communications segment for in the fourth quarter. For the same final period of 2021, the segment adjusted EBITDA was $10.6 billion, implying an EBITDA margin of 35%.
EBITDA is a good proxy for cash flows. The positive factor being that AT&T has been delivering robust cash flows from the communications division. This is important from two perspectives.
First, AT&T is looking at big investments in the next few years. Internal cash flows are likely to suffice. I don’t see a case for leveraging again.
Second, the dividend cut is likely to be temporary. Once the business gains further traction (backed by 5G), it’s likely that dividends will increase.
Media Division Growth
After the spin-off, it seems very likely that the media division will create value. It’s worth noting that for Q4 2021, WarnerMedia reported revenue of $9.9 billion and an adjusted EBITDA of $1.7 billion.
A positive catalyst for the media division is sustained growth in subscribers.
As of Q4 2020, HBO Max and HBO reported a global subscriber base of 60.6 million. By the end of last year, the subscriber base had swelled to 73.8 million.
For 2023, the merged entity had guided for revenue of $52 billion and an adjusted EBITDA of $14 billion. The merged division will also be targeting a free cash flow conversion rate of 60%.
Discovery (NASDAQ:DISCA) CEO David Zaslav also believes that the merged entity will have more than 400 million subscribers in the coming years. The outlook for the division is therefore positive in terms of growth and cash flow upside.
Concluding Views on AT&T Stock
I believe that the worst is over for AT&T stock in terms of balance sheet concerns and business headwinds. The company has made sustained investments in the 5G segment, which will deliver results in the next few years.
The media division spin-off is likely to create value even amidst intense competition in the live streaming business. A global addressable market will leave ample scope for growth.
Overall, T stock has limited downside risk from current levels. The upside potential seems significant in the next few quarters.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.