Selling a long-term position, while admitting you were wrong, is a difficult but necessary process for every investor at some point. Friday was that day for me regarding AT&T.
I was wrong about AT&T (NYSE:T), and in this article, I would like to come back to a trade I made this Friday by selling my position in AT&T and buying Unilever (UL) and STORE Capital (STOR) with the product.
AT&T has had a pretty exciting last few months with the big reveal of what the post-merger/spin-off company will look like. Just last Friday, after the market closed, AT&T closed the merger to create and spin off Warner Bros. Discovery (DISCK) (DISCB) (WBD) in a Reverse Morris Trust transaction.
AT&T shareholders will now own 71% of the media company at a rate of 0.241917 Warner Bros. shares. Discovery for each AT&T share held. The new AT&T, as part of this transaction, will receive $43 billion in cash and debt.
After the spin-off, the new AT&T will certainly be a more focused and financially sound organization. The vast majority of the proceeds owed to the company will be used primarily for debt reduction, which could reduce the debt balance to a still large, but more manageable, $165 billion.
The company also used this transaction as justification to bring the dividend back to a more sustainable level going forward, with a target payout ratio of 40% of projected FCF post-merger or $1.11 per share.
This payout ratio, at the combined company’s current price of $24.14, equates to a forward yield of 4.60%. It is estimated that shareholders will receive approximately $6 per share of Warner Bros. stock. Discovery and the AT&T post-spin will likely trade around $18 at Friday’s close.
why i sold
I’ve owned AT&T for what seems like an eternity, but in reality it’s only been about three and a half years. My original thesis was quite simple, AT&T is significantly undervalued and pays a very generous and covered dividend. In my portfolio, AT&T held the place of almost a bond substitute.
I’ve followed the company closely over the years and continue to believe Mr. Stankey’s management is doing the right thing to recover from costly mistakes in the past. My reason for selling this job comes down to one key point, I believe I can do better elsewhere.
The post-spin AT&T will certainly have a better financial profile thanks to the debt reduction and the reset dividend, however, the shares I would receive after the merger leave a lot to be desired.
AT&T, long-term, is going to struggle to grow EPS at a rate above 3% going forward, in my view. The real growth to be obtained would probably come from a multiple expansion.
Post-merger, the old AT&T will likely trade at a rather ridiculous 6.45 to free cash flow multiple. ($20 billion, 2022 FCF/7.16 billion shares = 2.79 per share/$18 post-spin price).
This multiple is certainly cheap, like almost all metrics in the company, however, for the multiple to grow in the future, a catalyst must emerge that allows long-suffering investors to believe again. Sustained growth, along with sincere debt reduction efforts, will likely be required over a period of several years before AT&T is awarded a similar multiple given to peer Verizon (VZ).
This may not be entirely fair given that it would appear that post-merger AT&T is actually in a better position overall than Verizon, both financially and based on recent phone results, however, this appears to be the case.
In addition to AT&T’s lack of future growth, Warner Bros. Discovery just doesn’t occupy the same place in my portfolio as AT&T. I really believe that Warner Bros. Discovery will be a successful company, however, the amount of debt it carries is certainly a big anchor tied to it from the start. I must admit that I find it difficult to properly assess the future prospects of Warner Bros. Discovery without further information.
Warner won’t be paying any dividends for the foreseeable future, which means the income from the entire position in Friday’s AT&T will be a 4.6% return, unless I dump the Warner shares and I don’t. buy them back into AT&T, which I imagine many investors will actually do. To do. Getting caught up in the riptide of this trade frankly doesn’t sound too appealing.
I set out to find an alternative investment for these funds which seek to generate higher income, protect my capital and allow for greater capital appreciation in the future. I believe that is exactly what I did by choosing to sell AT&T and invest the proceeds equally in Unilever and STORE Capital.
Why Unilever and STORE Capital?
In reviewing my options, I will assume that my investment in AT&T, had I done nothing at all, would return a total of 4.60%. Additionally, capital appreciation would likely be boosted by the multiple expansion. AT&T expected to trade at 2022 PE ratio of 7.37 post-merger on EPS midpoint orientation of $2.44.
Verizon, AT&T’s closest peer, currently trades at a forward PE ratio of 9.84, about 25% higher than AT&T. My bullish thesis has always been that AT&T should trade much closer to Verizon’s valuation, so in my AT&T position I was expecting a return of 4.60%, potential capital appreciation of 25% and a EPS growth of around 3%.
The goals I’m looking to beat are: a return above 4.60%, potential appreciation above 25% through multiple expansion, and EPS growth above 3% over the long term, all while staying within conservative sectors to help preserve my capital.
Unilever and STORE Capital both operate in the historically conservative consumer staples and real estate sectors, ticking the boxes for capital preservation from the outset.
Unilever, a consumer staples powerhouse now based in London, has recently been hammered by war in Ukraine as well as commodity inflation that has swept the world. Shares of the company have been hit much harder lately than their core counterparts Colgate (CL) and Procter & Gamble (PG).
This recent underperformance only adds to the stark valuation difference between the 3 peers, as Unilever is currently trading at a forward PE ratio of 16.37, a nearly 36% discount to 24, 52 at Colgate and 27.25 at Procter & Gamble.
Unilever currently seems mired in a crisis of sentiment all its own given European roots and the war in Ukraine, however, the company has an impressive roster of billion-dollar global brands and a lasting moat given the vast distribution and manufacturing scope of the company. .
The company’s long-term EPS growth rates are estimated to average 6% going forward, and in addition, the company pays a well-covered dividend yield of 4.37% along with an A+ credit rating. /A1 stable with S&P and Moody’s.
STORE Capital, a triple net lease, real estate investment trust, is focused on the acquisition and sale-leaseback of single-tenant retail, service and manufacturing properties.
Shares have also been hit quite hard recently, primarily by the departure of Christopher Volk, the company’s co-founder and recent executive chairman. The news and the reasons for his dismissal have been the subject of much speculation, however, I believe that the simplest explanation may indeed be the best, the company may have seen no reason to keep him , he and his substantial compensation package, further into the not-day-today role of chairman.
Like Unilever, 2022 so far has not been kind to STORE Capital compared to its peers. In the case of STORE, triple net lease peers Realty Income (O) and Agree Realty (ADC) have fared much better year-to-date.
This underperformance is also reflected in the valuation levels assigned by the market. STORE Capital is currently trading at a forward FFO multiple of just 14.62, where Realty Income is trading at 18.89 and Agree Realty at 18.06. STORE Capital is currently trading at a nearly 21% discount to its peers.
I consider this reduction as unjustified. The company has operated at a very high level and is expected to grow its long-term FFO by at least 5.5%, while delivering a hedged return of 5.19% and a growing dividend yield. Additionally, the company holds a positive outlook at S&P with a BBB rating and a stable BBB rating at Fitch.
Mary Fedewa, CEO of STORE, is also a co-founder of the company and is a very talented executive with many years of experience. During the fourth quarter earnings call, she indicated no change in strategy or direction that she and Mr. Volk have developed together over the years, as well as strong results and direction for the future. The company is obviously in very good hands with Ms. Fedewa.
Blending the key metrics discussed above, I created a chart showing how a combined UL and STOR position beats my previous AT&T position on forward total return, potential capital appreciation through multiple expansion at peers and long-term EPS/FFO growth going forward .
|Vehicle||Yield||Potential capital appreciation||Long-term EPS/FFO growth|
Using strictly static valuation multiples today, I would expect the combined UL/STOR position to return 10.53% annually based on EPS growth and dividend yield. Legacy AT&T, even if you sold WBD and reinvested in AT&T, would only return you 9.10% (6.10% return and 3% EPS growth).
I’m really sad to see my position at AT&T go, I sincerely believe the company can be a worthwhile investment in the future, however, any realistic growth in the markets AT&T competes in will be very hard to come by. future and it is clear that better alternatives exist.
I believe a combination of UL and STORE Capital in the future is likely to provide longer term growth and revenue than AT&T’s current offering. Plus, I get the nice benefit of a capital loss on my taxes, which is about 4% more incentive on this trade.
Sometimes an investment just doesn’t work, and instead of raging against the injustice of it, you need to cut the bait and find a better alternative. I believe I did with this trade.
Although I give a caveat, given my luck recently, you may soon see new highs at AT&T.
I look forward to your comments below. Thanks for reading and good luck everyone!