Forget Apple, Ring up AT&T

10/28/2013 10:00 am EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

In Conrad's Utility Investor, income specialist Roger Conrad suggests that investors not get caught up in the hype around smartphone makers; rather, he looks to the telecom sector for better ways to play the growth of this market.

Steve Halpern: Joining us today is income investing expert, Roger Conrad, Editor of Conrad's Utility Investor. How are you doing, Roger?

Roger Conrad: Real good, Steve.

Steve Halpern: You recently wrote a pretty controversial article that I'd like to go through regarding Apple (AAPL). You say Apple is a company that you like, but you wouldn't necessarily be buying the stock and you don't recommend it, either for growth, or income investors. Could you explain?

Roger Conrad: Well, you know, I think this is obviously a name that's gotten a lot of press, and at one point, really got bid up to very high levels, and then of course became well-off earlier this year and that's—we got interested in it at that point, but only, pretty much, for a contrarian kind of growth play.

You know, a lot of these technology companies have gone out and started paying dividends simply—you know, it's, obviously dividends that are pretty popular these days, but a lot of companies have started playing them simply for that reason, to get interest in their stock.

I think Apple is one of them, but I do think, if you look at the volatility in the stock, you look at, really, it's—when it's interesting is when it's cheaper, and when the people are down on it. It's not a company that—it's a company that's had a lot of recent growth, but now it's kind of settling, I think, into a more mature phase.

I think the hiring of the Burberry CEO as, potentially as marketing director, is pretty much a step in that direction, I think, so, I think the company is going to do quite well, but I don't think that it's going to be anything, what it was in the past.

I think it's going to be interesting for investors as a comeback play when it does get beaten down, because there's very few companies where so much has ridden in; earnings are scrutinized, as Apple is, pretty much every move they make, so there's going to be a lot of action.

But, you know, if you look at the dividends, it's pretty hefty in terms of dollar terms, but the daily fluctuations in the stock are often greater than the amount of payment. So, this is one that I think it's a trading stock, I think, like many of the technology names, not a stock that people want to own for income.

Steve Halpern: So, despite your aversion to buying into the Apple story, you are still a fan of the long-term growth story in the smartphone market and you look at AT&T (T) as a better way to play that growth. Could you expand on that?

Roger Conrad: Well, you know, I think one of the things that, you know, obviously you look to buy low and sell high and you look for the part of the market where people aren't maybe as excited about, and AT&T has grown right along with Apple and the smartphone market.

Verizon (VZ), you could also throw in there, but if you look at these two companies, they've done about two-thirds of the capital spending over the past three years and they've done it without, while paying rising dividends, and you know, without running up debt.

In fact, they've been reducing their debt load, generally strengthening their balance sheets, and the reason they've been able to do this is because of tremendous amounts of cash flow they're generating and also because the more they spend on their network, the harder it is for a rival to keep up.

They've again, outspent the next—AT&T has outspent numbers three through 15 in the US communications market, and that three through 15 includes companies like Comcast (CMCSA), Sprint (S), T-Mobile USA (TMUS), Time Warner (TWX), so some rather large companies that have been making a lot of noise in the press, but AT&T continues to outspend them, outspend pretty much everybody except for Verizon—they're pretty much neck and neck.

But you look at those two companies, they continue to get market share in the smartphone market and they're even doing so in the face of hostility from sometimes overt, sometimes covert, from the Federal Government, which has an idea that it wants a certain number of competitors in the field.

So, you know, it's a—I've called it a—you know, it's pretty much a game or a capital game, I guess, in terms of companies that are able to spend more on their networks, become more dominant, and at the same time, Apple is facing an ever greater amount of competition; is in fact, losing ground to not just to Samsung (SSNLF), but also to, you know, other smaller producers of those devices around the world.

They're having to retreat something into kind of a brand identity mode, whereas companies like AT&T, they're selling more and more smartphones and they're dominating that market.

We may see AT&T go to Europe, I think—the stock could trip up a little bit if that is the case, but, because people are going to worry about whether it's able to apply its formula there, but this is a company with, again, mountains of cash and in a business where that's the single most essential element to a long-run success.

Steve Halpern: Now you outlined a number of positive factors regarding AT&T, but Wall Street isn't particularly enamored with the stock. In fact, in your latest research, you note that of the analysts covering the stock, 11 rated a buy, while 25 rated a hold, and three even rated as a sell. How do you explain the skepticism from the Wall Street community?

Roger Conrad: And you know, also, if you turn that around, you know, you'll see that Apple almost draws universally high marks. I think the reason that AT&T is, you know, has this degree of skepticism against it is precisely because, you know, investors look over into Europe and they see the market there, which is fragmented.

There are many more service providers than the market can support, and we've seen that with lackluster earnings and the attempts of many of those companies to merge together, which may or may not be successful, so a lot of people look at that and sort of the apply the same lesson.

I think it's a little bit of a different story here, because, well, for one thing, you know, this is a market somewhat geographically isolated from Europe, but it's pretty clear that, over time, that companies that have been able to spend on capital have been able to grow markets here.

And there's also, I think, some skepticism about companies that spend a lot of money, and of course, a lot of people are concerned about capital spending with the threat of Fed tapering at some point and higher interest rates, but again, that's going to hurt their competitors, I think, a lot worse than AT&T or Verizon.

They are also stocks people love to hate, but I have seen, actually, over the past, just five or six years, actually, a growing optimism or less of that pessimism. We used to always see, when AT&T or Verizon would announce earnings, just a lot of negative opinion, pretty much focused on the loss of traditional phone business.

That, of course, is now a non-issue for both those companies. They've been able to really transition everything to broadband and wireless, and in those two areas, they're growing revenue, so the traditional phone business, whatever losses there are there, are being dwarfed by this other growth and they've successfully made the transition, so you don't hear that critique anymore.

What you hear more of are things like, "Well, maybe, you know, Sprint and T-Mobile are cutting prices and they're going to make hay out of this cheap Apple iPhone" and so forth, so everybody's looking for the—they're still looking for what's going to tear these companies down.

But every time we get through earnings, and this time around, it's pretty obvious that the upscale iPhones have far outsold the lower scale ones, so it looks like it could be another tough quarter for these, and the whole second half of the year, and going forward, for pretty much everybody else in this business, except AT&T and Verizon.

And again, you know, I think this is something that's only coming to be recognized very slowly in the market, maybe a little bit at a time, but while it is not being fully recognized, you do have bargains in some of these stocks, like AT&T and Verizon may be a little expensive right now, but again, these companies are doing what they need to do to dominate this market, and increasingly so.

Steve Halpern: Now, finally, you've been pointing out some of the growth opportunities in the stock, but it also offers a pretty high yield, about 5%. Would you be recommending AT&T for income advisors as well?

Roger Conrad: Yeah, I think so. I think if, you know, if you look at, in what we cover in Conrad's Utility Investor, it's all the essential services: electric, gas, energy distribution, water, and communications, and these are all essential services that we're using more and more of.

It makes for very reliable revenue for the companies that dominate the business, and again, you know AT&T and Verizon do dominate this business and they have quite reliable revenue.

These dividends are backed up by free cash flow, and again, like I said, they're growing the business and staying ahead of the competition, even as they generate enough free cash flow to bring down debt and pay dividends, so they're very well secured.

I think we'll continue to see these dividends grow over time, so I think, that for income investors, this is yielding around 5% with an undervalued stock that's, again, dominating a very essential market.

Steve Halpern: Well, thanks for taking the time today. We really appreciate your insights.

Roger Conrad: Well, thanks, Steve, very much.

Subscribe to Conrad's Utility Investor here...

Related Articles on STOCKS