Better Buy: AT&T, Inc. vs. Verizon

AT&T (NYSE: T) and Verizon (NYSE: VZ) combine to hold about 70% of the U.S. wireless market. Their share of the profits in the industry are even higher, as smaller competitors T-Mobile (NASDAQ: TMUS) and Sprint (NYSE: S) lack the benefits of scale afforded to the telecom giants. (That's a big reason the two smaller companies agreed to merge.)

Investors who want a company capable of producing strong and steady cash flow are probably interested in AT&T and Verizon. Both companies throw off lots of cash that they use to invest back into their wireless networks and marketing to keep winning customers and still have plenty left over to return to shareholders.

But if an investor could only choose one, AT&T or Verizon, which is the better buy?

AT&T's a whole new company

Over the past three years, AT&T has made two massive acquisitions: DIRECTV and WarnerMedia (formerly Time Warner).

The DIRECTV acquisition gave AT&T the ability to offer pay-TV service nationwide instead of being confined to the physical footprint of its U-Verse service. It also came with a $49 billion price tag and about $18 billion in acquired debt.

Over the summer, AT&T closed its acquisition of WarnerMedia for a cool $85 billion. Its debt levels have climbed above $190 billion, making it the biggest non-bank debt issuer in the United States.

With so much investment in its entertainment business over the past three years, investors might expect improved profitability. But in fact, AT&T has experienced deteriorating profitability in the entertainment group as more people cut ties with traditional pay-TV and opt for virtual providers. AT&T has had success with DIRECTV Now, but the profits are somewhere between slim and none on that product.

That said, AT&T's core wireless business continues to be the cash-generating monster it's always been. It's seeing growing profits even as it's investing heavily in its network. Last quarter, the company managed to add 46,000 postpaid phone subscribers and 356,000 prepaid customers. That's not as great as competitors like T-Mobile, but it's a strong improvement from the past couple of years, when it was losing postpaid phone customers.

Right now AT&T's debt load puts it in a precarious position where its WarnerMedia and DirecTV investments need to pay off and the wireless industry can't stumble. While management has a plan in place to pay down the debt, it could curb growth in capital returns to shareholders, which is a big attraction to AT&T stock.

Verizon's wireless business is still the focus

Verizon hasn't been entirely immune to acquiring assets outside of its core wireless business, but it hasn't spent tens of billions either. The company acquired both AOL and Yahoo!, combining them into Oath. Oath generated about $1.9 billion in each of the first two quarters of 2018 -- a considerable but not very large part of Verizon's business.

Verizon's core wireless business still accounts for the vast majority of revenue and profits. The key advantages for Verizon, however, are being undermined by T-Mobile and Sprint.

Verizon still has a strong brand and a strong network to back it up. Those are both evidenced by its industry-leading retention rates for its postpaid phone customers.

But Verizon's ability to command premium pricing is deteriorating. It's creating new tiers of "unlimited" data plans and offering customers the option to pick and choose plans for each individual in their family plan. Verizon is adding more new customers than AT&T since introducing unlimited plans last February, and it's starting to show year-over-year service revenue growth because of it.

But with network performance across Verizon, AT&T, and T-Mobile nearing parity, Verizon will have to compete on price and customer service. That could eat into profit margins in the future. It's unclear whether the combination of T-Mobile and Sprint will ease the competitive pressure on the wireless business.

That said, Verizon has managed the pressure just fine so far. Despite the decline in service revenue, it's managing industry-leading profits and profit margins.

Comparing them head to head

Verizon is a more focused company with a bigger competitive advantage in wireless stemming from its scale, its brand, and its network. Those three factors are becoming less advantageous over time, however.

AT&T is driving customer growth through aggressive bundling with its entertainment group, which has ultimately turned into a burden of deteriorating profit margins and a load of debt.

Verizon's EV/EBITDA ratio of 8.1 is slightly better than AT&T's 8.6, but AT&T's trailing-12-month EBITDA includes just 16 days of WarnerMedia results. Both trade at premiums to T-Mobile and Sprint.

Given Verizon's more manageable debt-to-EBITDA ratio of 2.7 versus AT&T's 3.9 ratio, Verizon still looks like a better buy than AT&T.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.