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Telecom Stocks

AT&T and Apple: The Balance Shifts to Carriers

By Roger S. Conrad on Apr. 26, 2014

Last September, we urged income-seeking investors to resist the allure of Apple’s (NSDQ: AAPL) newly installed dividend.

Instead, we highlighted a company that had long been in the device maker’s shadow, but is infinitely more durable and well-suited for paying out its cash: AT&T (NYSE: T).

Following the market’s favorable reaction to Apple’s results for its fiscal second quarter, many analysts would pretend they never doubted the stock and touted an underperforming alternative. (Apple’s shares have returned 21 percent since the end of last year’s third quarter, while AT&T has delivered a 6 percent gain.)

Nonetheless, conservative income-seeking investors who own Apple need to make the switch–and soon.

For one thing, Apple’s operating numbers didn’t wow the crowd; rather, the market reacted to a 7.9 percent increase to the quarterly dividend, as well as the announcement of a 7-for-1 stock split and $30 billion increase in stock buybacks.

The tech darling grew its net income by about 7 percent from year-ago levels, while its revenue ticked up by 5 percent–a big letdown from the heady numbers of years past.

Although sales of the company’s iconic iPhone increased on a year-over-year basis, last fall’s major redesign of the iPad didn’t prevent sales of the tablet from slipping.

This mixed news hardly justifies the triumphalism of the company’s many backers over the past few days. In fact, it’s reason to question how long Apple’s recent price jump will last.

Apple is an admirable company. And demand for iPods, iPhones, iMacs and iPads–all of which I use–won’t go away anytime soon. Tapping Vietnam and other underpenetrated international should also help the company move the needle on sales.

At the same time, Apple faces intense competition in a handset and tablet market that has become increasingly commoditized. The company’s global market share has dropped to about half that of arch rival Samsung Electronics (Seoul: 005930, OTC: SSNHZ), which has made serious inroads on Apple’s home turf.

Apple’s results for its fiscal second quarter ended March 29, 2014, reflect this reality.

Apple also faces a potential blow from a far more subtle development: The phase-out of subsidized phone sales. The need of self-styled “uncarrier” T-Mobile US (NYSE: TMUS) drive sales growth by offering lower-priced contracts started the trend.

AT&T and other providers have jumped on the bandwagon, launching their own plans that bill customers for devices in exchange for not requiring contracts.

Consumers enjoy added flexibility and lower rates. Meanwhile, carriers benefit from not absorbing equipment costs. Apple and other handset makers, however, face a potential decline in sales if customers are incentivized not to upgrade their phones.

Previously, the rapid advances in handset design and technology had favored handset makers. A few years ago, Sprint Corp (NYSE: S) agreed to purchase $20 billion worth of iPhones, lining Apple’s pockets and destroying its own profit margins.

T-Mobile to the Rescue

AT&T owes this development to T-Mobile US, the company that the financial press often depicts as its chief competitor and tormentor. In the first quarter, AT&T and Verizon Communications (NYSE: VZ) lost lower-end wireless customers to T-Mobile US.

However, AT&T also grew its total revenue by 3.6 percent from year-ago levels–its best improvement in two years. And the company increased its wireless cash flow margins by a whopping 220 basis points to 45.4 percent.

Overall customer churn fell sequentially for the second consecutive quarter. Even wireline margins ticked up 40 basis points to 19.3 percent, despite ongoing customer attrition.

Subscribers can read my full analysis of AT&T and Verizon Communications in Monday’s Utility Roundup. Not a subscriber? Learn more about signing up for a risk-free trial of Conrad’s Utility Investor.

All signs indicate that AT&T’s business continues to strengthen despite a challenging competitive environment.

Moreover, the company continues to support industry-leading capital spending ($5.72 billion in the first quarter), while still generating sufficient free cash flow to pay dividends, repurchase stock and pay off debt.

Of its telecom rivals, only Verizon Communication can say the same. In fact, Sprint and T-Mobile US likely will report lower profit margins and higher debt when they announce their first-quarter results.

T-Mobile US’ efforts to shore up its profit margins bet that ending handset subsidies will offset the expenses associated with its expensive marketing campaign.

The same goes for Sprint, though its onerous agreement with Apple will hamstring the firm’s push for profitability. Sprint plans to make all its devices un-lockable–meaning they can be used on rival networks–by Feb. 11, 2015.

Taking a Bite Out of Apple

The cachet of Apple’s devices may prevent a material drop in sales if carriers phase out handset subsidies completely.

With the company’s shares trading at almost 3 times sales and 44 buy ratings from analysts, the stock hasn’t priced in this risk.

And those who trumpet Apple’s dividend are drawn in by window-dressing that doesn’t provide one iota of support to the stock price.

Despite some pundits’ assertions to the contrary, Apple remains a growth stock–not a utility-like name that builds wealth over the long run through accumulated dividends and steady price appreciation.

Although momentum is going Apple’s way at the moment, the stock price reflects a high bar of expectations; a quick reversal could be in store when the bears rally their forces. 

Steady Cash Flow Growth from an Essential Service

In contrast, AT&T sports a dividend yield of 5.4 percent–more than two times the current return offered by Apple’s shares–and trades at a more reasonable 1.4 times sales.

And despite lukewarm investor sentiment, insiders have increased their holdings by almost 8 percent over the past six months.

Unfortunately, the company’s steady results and regular dividend growth won’t turn analysts into telecom bulls overnight. But AT&T should have no problem overcoming the market’s low expectations.

Management reportedly remains interested in making a European acquisition, with regulators’ concerns about the US national security apparatus the primary sticking point. An announcement would almost surely bring out the skeptics in large numbers, and the stock could sell off again.

This risk means that investors shouldn’t chase the stock too far beyond its current price.

But you’d be hard-pressed to beat AT&T for steady growth and reliable income–especially in a market where too many are blindly bobbing for Apples.

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ABOUT ROGER CONRAD

Roger S. Conrad needs no introduction to individual and professional investors, many of whom have profited from his decades of experience uncovering the best dividend-paying stocks for accumulating sustainable wealth. Roger b