Perhaps the one bit of good news here is for dividend investors. Merrill Lynch sees AT&T’s dividend as safe, despite the many concerns that merger investors might have had. The report said a dividend cut is unnecessary, as follows:
Several early press reports floated the idea AT&T would use an acquisition of Time Warner as an opportunity to reduce its dividend. AT&T has described its dividend as ‘sacrosanct’ and expects better coverage following the acquisition. Our analysis suggests that a dividend cut is not necessary to enable an equity-heavy deal of this size and, in fact, dividend coverage actually improves.
One blow that is obvious here is that Merrill Lynch is now using a much lower multiple for how it values AT&T’s earnings ahead. The $39 price objective is using an earnings multiple of just 13.5 times 2017 earnings, down from its previous multiple of 16 times earnings. This is now at the low end of AT&T’s historical valuation range relative to the S&P 500. The report said:
We believe AT&T relative multiple expansion will be constrained by a number of factors including the expected upcoming stock issuance, treasury yield spread and a tightening of the deal spread. At the same time, we believe this very low relative valuation offers support to AT&T’s current share price. Our target implies ATT can close roughly half the gap between its current and its long term average relative PE.
It’s always interesting to see summary and rationale commentary of a key stock when a firm downgrades its rating after having been positive for so long. The Merrill Lynch rationale looks quite different on July 13 than after the last earnings report in April.
Back on April 26, after lowering earnings estimates based on earnings, Merrill Lynch still had a Buy rating and a $46 price objective. The firm’s investment rationale at that time said:
AT&T is fundamentally sound, with a stable subscription-based business model. Historically, the stock has outperformed during periods of M&A and wireless margin expansion fueled EPS growth and during periods of market uncertainty when AT&T’s dividend yield, solid balance sheet and predictable business model are highly valued. We expect AT&T will generate improved financial performance post acquisition of DTV with upside to consensus EPS, greater dividend coverage and upside to synergy targets.
The new investment rationale from July 13 said:
AT&T is fundamentally sound, with a stable subscription-based business model. Historically, the stock has outperformed during periods of M&A and wireless margin expansion fueled EPS growth and during periods of market uncertainty when AT&T’s dividend yield, solid balance sheet and predictable business model are highly valued. We believe multiple expansion is limited in the near term by anticipated share issuance associated with TWX and near term fundamental headwinds.
Thursday’s midday trading had AT&T trading down another 1.3% to $36.36, in a prior 52-week range of $36.10 and $43.50 and with a prior consensus analyst target price of $40.73. The highest official analyst target was last seen at $48.00.
Wall Street investors already have been tough on AT&T during 2017. Its shares were down about 13% so far in 2017, and AT&T’s chart has been in a steady state of decline since March. Now the stock is challenging its lows from last October and November. AT&T’s chart put in lows close to $32 at multiple points in the past five years.