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AT&T: Dialing Up Growth

By Chad Fraser on March 26, 2014

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The utility sector continues to experience significant changes.

The U.S. energy utility industry, for example, is being reshaped by a combination of cheap natural gas, new technologies and changing environmental regulations.

Meanwhile, the telecom business could see greater consolidation if a proposed merger between No. 3 carrier Sprint (NYSE: S) and No. 4 player T-Mobile U.S. ever comes to pass. However, a deal still seems unlikely after regulators blocked AT&T’s (NYSE: T) own proposed acquisition of T-Mobile in 2011.

Sprint is controlled by Japan’s Softbank, whose CEO, Masayoshi Son, aims to combine the two smaller players to build sufficient scale to take on AT&T, which has 110.4 million wireless customers, and Verizon, with 102.8 million. Sprint, for its part, has 54 million, while T-Mobile has 46.7 million.

A Powerful New Tool

In response to continued changes in the utility sector, our Utility Forecaster advisory has launched a new system that gives our analysts another tool for monitoring the strength and growth prospects of Utility Forecaster’s portfolio holdings, as well as any potential new additions.

David Dittman and Richard Stavros, the experts behind Utility Forecaster, call it the “DuPont Hybrid Model,” because it’s based on the original DuPont model, developed in 1919 by a finance executive at E.I. DuPont de Nemours & Co.

Put simply, the system deconstructs a company’s return on equity (ROE)—a measure of how well management uses shareholders’ funds to generate profit—into its individual components. That makes it easier to analyze what’s actually driving growth: increasing profitability or something else, such as higher leverage, that could undermine the company’s future health.

What’s more, it helps tip them off to potential dividend cuts. That’s because there appears to be a strong correlation between ROE and the sustainability of a company’s payout. This finding was revealed by analysts at Charles Schwab, who examined dividend payers among the top 3,200 stocks (by market cap) and found that those with high ROEs were less likely to have cut their payouts.

Why AT&T Makes the Grade

Stavros recently ran our new DuPont Hybrid model on one Utility Forecaster Growth Portfolio holding whose ROE has been strengthening: AT&T.

The verdict? The increase is being driven by rising profitability. “During the fourth quarter, AT&T’s quarterly profit margin jumped to 20.9% after averaging 11.9% for the preceding three quarters,” wrote Stavros in a February 28 Utility Forecaster article.

Here’s a closer look at the company:

AT&T is the No. 2 U.S. telecom stock by market cap, behind Verizon. Its wireless operations accounted for 54% of its revenue in 2013, while its wireline business (high-speed Internet, TV and home phone) supplied 46%.

In the fourth quarter, the company earned $6.9 billion, or $1.31 a share, up from a loss of $3.9 billion, or $0.68, a year ago. On an adjusted basis, AT&T earned $0.53 a share, up 20.5% and ahead of the consensus forecast of $0.50.

Revenue ticked up 1.8%, to $33.2 billion, also topping the Street’s estimate of $33.06 billion.

In all, the company added 809,000 new wireless subscribers in the quarter, with 566,000 being postpaid, or under contract, including 299,000 smartphones. In all, 77% of the company’s postpaid customers now carry smartphones, up from 70% a year earlier. That’s a key figure for AT&T, because smartphones generate higher average revenue per user than regular cellphones.

The wireless business’s total revenue rose 4.5%, to $18.4 billion. Service revenue gained 4.8%, while data revenue jumped 16.8%. The division’s operating earnings rose 53.8%. Wireline revenue, meanwhile, slipped 1.4%, while operating income fell 18.8%.

The company forecasts 2% to 3% overall revenue growth in 2014, with adjusted earnings per share rising “in the mid-single digits,” excluding the impact of share buybacks.

Massive Scale Outweighs Competition Worries

AT&T continues to deal with rising competition in the mobile space, including from smaller players like T-Mobile. That’s been weighing on shares of both AT&T and Verizon in the past year:

“The reason, some market analysts believe, is due to concerns over an escalating price war in the mobile phone industry that could negatively affect future profits and dividends,” wrote Stavros. “AT&T, for instance, recently announced it would lower the price of its family data plans, which could come at the expense of Verizon. But more than competition between these two large rivals, market analysts believe an even bigger threat will come from smaller upstarts.”

However, Stavros also feels this view overlooks the telecom giants’ unparalleled ability to invest in their wireless and wireline networks (in all, the pair accounted for 54% of total U.S. network spending last year) and the key role that plays in helping them benefit from rising demand for mobile data.

According to a recent report from Cisco Systems (NasdaqGS: CSCO), global mobile traffic will grow 11-fold from 2013 to 2018, for a compound annual rate of 61%. That’s three times faster than the forecast growth over fixed networks. The U.S., meanwhile, is headed for an eightfold mobile-traffic increase.

AT&T’s 4G LTE wireless network is now nearly complete and reaches 90% of the U.S. population. This year, the company is planning capital expenditures of $21 billion, roughly equal to 2013. Verizon, by comparison, plans to spend between $16.5 and $17 billion on its networks, compared to $16.5 billion in 2013.

“Industry growth is being driven by accelerating demand for specialized services, including cloud computing, M2M (or machine to machine, which refers to technologies that allow both wireless and wired systems to communicate with other devices) and cybersecurity,” writes Stavros.

The M2M market could present a particularly lucrative opportunity for the major carriers: tech market research firm Ovum pegs M2M wireless revenue at $44 billion in 2018, up from just $13 billion in 2013. Notably, that figure includes only industrial equipment, not consumer devices.

“Investors Should Take Note”

AT&T also has a long history of paying dividends. The stock currently yields 5.3%, above Verizon, at 4.5%. It trades at 13.1 times AT&T’s forecast 2014 earnings, which compares favorably to Verizon, at 13.5, and the S&P 500, whose forward p/e currently stands at 15.75.

The bottom line? “Certainly, Utility Forecaster’s new DuPont Hybrid Model shows a sustained trend of profitability, or value creation, of which investors should take note,” writes Stavros.

Let our proven Utility Forecaster Safety-Rating System—now backed up by our powerful DuPont Hybrid Model—guide you to the best utility picks for growth and income when you take a risk-free 90-day trial subscription. You have nothing to lose and much to gain. Click here to start yours now.

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