AT&T (NYSE: T) surged from $32 last November to $43 in July, fueled by robust demand for dividend stocks and its cash flow-boosting purchase of DirecTV. Since hitting that peak, AT&T stock has pulled back to around $37 on various concerns about its future.
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Image source: AT&T.
But as a long-term AT&T investor, I believe that many of those concerns are overblown. Let's examine the four common bearish arguments against AT&T, and why I believe that they're terrible reasons to sell this solid income stock.
1. Higher interest rates
Many high-yield dividend stocks, including AT&T, outperformed the S&P 500 over the past 12 months as low interest rates sent investors scrambling for higher yield investments. But as interest rates inevitably rise again, income stocks like AT&T will become less attractive than the guaranteed returns of bonds.
While that may be true for many income stocks with inflated P/E ratios, AT&T currently trades at 16 times earnings, compared to the industry average of 25 for domestic telcos. Furthermore, the benchmark 10-year Treasury yield of 2.3% remains much lower than AT&T's forward yield of 5.3%.
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2. The Time Warner deal
When AT&T announced thatit would buy Time Warner (NYSE: TWX) for over $85 billion, the bears warned that the acquisition could be as disastrous as the AOL-Time Warner merger in 2000, which resulted in a $99 billion write-off justtwo years later.
However, buying Time Warner helps AT&T counter the expansion of younger tech companies into its backyard. For example, Netflix's growth convinced many consumers to dump their bundled pay TV subscriptions for cheaper broadband-only plans. To address that demand, Alphabet's Google then launched itsFiber wireline service, Google Fi wireless service, and Google Station Wi-Fi service.
Those streaming and broadband services all threaten AT&T's position as a leading ISP and pay TV provider. However, buying Time Warner gives AT&T the power to bundle the latter's media assets (like HBO) with DirecTV -- which is already bundled with its unlimited wireless data plans. It could alsooffer "data free" streaming of those first-party services for its wireline and wireless customers. Other companies, like Netflix, still have to pay AT&T for data-free streaming.
3. Higher debt reducing its dividends
Last February, credit rating agency Moody'sdowngraded AT&T's senior unsecured notes ratingfollowing its $18.2 billion purchase of AWS-3 spectrum licenses and its $49 billion purchase of DirecTV. In late October, Moody's issued another downgrade warning afterthe Time Warner deal was announced.
Moody's warned that AT&T's rising debt levels following the deal -- which would boost its adjusted gross leverage from about 2.8x today to 3.5x -- could eventually force AT&T to reduce its dividends. However, AT&T is very unlikely to cut that dividend -- which it's hiked annually for over 30 years to become an elite "dividend aristocrat" -- unless its free cash flow completely dries up. That scenario seems unlikely if we look at AT&T and Time Warner's FCF growth over the past five years.
4. The saturation of the wireless market
AT&T's wireless subscriber base grew by 2.3 million. Much of that growth was fueled by its Cricket prepaid wireless phones and its growing Mexican business. However, AT&T also lost 268,000 mainstream U.S. wireless phone customers dueto tougher competition and the saturation of the smartphone market.
But including "other" wireless devices, AT&T mainstream's U.S. wireless subscriber base actually grew by 212,000. Those "other" devices include connected vehicles, which require better stand-alone connections for their infotainment and navigation systems, and autonomous drones, which can fly across AT&T's 4G networks.
Back in January, AT&T announced that it would offer stand-alone conenctionsto 10 million Ford vehicles in North America by 2020. The following month, it tested out theworld's first LTE-connected drones with Intel. Growth in these adjacent markets -- coupled with its growth in the prepaid and Mexican businesses -- should prop up its wireless business even as its U.S. smartphone subscription rates decline.
The key takeaway
I'm not saying that AT&T has a flawless business strategy, but I believe that the specific fears about higher interest rates, Time Warner, its debt levels, and wireless "losses" aren't compelling reasons to sell the stock.
Instead, investors should focus on the fact that AT&T is trading at a steep discount to the industry while offering a hefty dividend yield which is more than double the S&P 500's average yield of 2.1%. Therefore, I personally plan to tune out the noise and stick with my original plan of holding AT&T for the long term.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of AT and T and Ford. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Ford, and Netflix. The Motley Fool recommends Intel, Moody's, and Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.