AT&T vs. Verizon: Which Is the Better Stock?

Telecom stocks have long been thought of as reliable dividend payers whose growth days are behind
That’s pretty much true.
That’s why you see telecom companies get mentioned frequently as merger partners for cable or satellite TV companies, or with content providers.

Indeed, because growth prospects aren’t what they once were, AT&T (NYSE: T) purchased DirecTV (NASDAQ: DTV) for $95 per share almost a year ago. The market is waiting for the merger to go through, and investors appear skeptical it will happen, since DirecTV trades at $87.
AT&T needs the merger to go through for it to have any kind of real growth going forward, because at this point, both AT&T and competitor Verizon Communications (NYSE: VZ) are essentially commodity companies.
Competition between telecom companies is positively brutal, and I’ll illustrate by way of personal anecdote.
Verizon called me out of the blue last month and offered to double my data plan capacity at no additional cost. I also received a $6 monthly credit, called a “customer retention” promotion. The very next day, AT&T called me because I had switched to a cable Internet provider. They didn’t convince me to come back, but they did give me a monthly credit of $6 on my landline.
And that is what happens in a commoditized sector. Consumers win, companies lose.
So does that mean telecom stocks aren’t worth holding? Yes and no.
Let’s look at the financials of each and find an investing takeaway.
AT&T vs. Verizon
AT&T has $8 billion in cash and $76 billion in debt. DirecTV carries $4.6 billion in cash and $19.5 billion in debt, meaning the combined entity would have a whopping $96 billion in long-term debt. The good news is that total interest expense “only” comes to $500 million, or about a 4.6% interest rate.
The combined entity will generate $166 billion in revenue annually, although the growth rate for that revenue is only about 3%. The bottom lines, however, are basically no-growth at this point. Any growth is being goosed by stock repurchases.
So while it’s all well and good that the combined entity has $9 billion in net income, I don’t want to overpay for  zero growth. So the issue comes down to cash flow, and whether the 5.6% yield is sustainable, because I don’t think the stock price will be going anywhere.
AT&T’s free cash flow has declined from $20 billion in fiscal year 2012 to $10 billion in FY14. DirecTV’s free cash flow has been increasing from $2.6 billion in FY12 to $3 billion to FY14. So, there is coverage on the dividend, but since that dividend was $10 billion, the combined entity doesn’t have a lot of buffer.
Verizon isn’t much better. It is growing earnings per share at a 7% long-term rate. Revenue grew 5.5% in 2014, although net income fell from $11.5 billion to $9.6 billion. It is also loaded with $110 billion of debt, at about 4.6% interest.
Free cash flow is also shaky. Verizon moved from $15 billion in FY12 to $22 billion in FY13, and then back down to $13 billion in FY14. However, the dividend payment of $9 billion is well-covered.
Overall, there isn’t a clear choice as far as I’m concerned. Neither company is in danger of going out of business, but neither has big upside potential. Verizon pays a dividend of $2.20 per share, and AT&T pays $1.88. Verizon’s yield is lower, but its capacity is higher.
I don’t think AT&T has a dividend cut in its future, but I wouldn’t rule it out if the combined business with DirecTV takes a bad turn.

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