American Tower (NYSE: AMT) released its first quarter 2022 results on April 27, 2022. It reported strong double-digit growth in real estate revenue. Growth is supported by the acceleration of new rentals and new asset inflows in recent quarters. And in the in the longer term, there is no indication that the growth rate will slow down. Our society will only use more and more wireless devices and more and more data. Mobile data usage is expected to grow at a CAGR of 23% through at least 2026 due to the growing number of devices and increasing usage per device. As CEO Tom Bartlett commented (emphasis added by me),
The growth of our core business in the United States and Canada continues to be propelled by the rapid acceleration in mobile data consumption that we have seen over the past decade. In 2017, the average smartphone in the United States consumed approximately six gigabytes of data per month. And today, in the early stages of consumer adoption of 5G, that number has grown by 240% to more than 20 gigabytes on a monthly basis.
In terms of valuation, the recent price correction has created an entry opportunity as assessed by two independent methods later in this article. First, you will see that it is attractively valued in terms of immediately lower cash flow multiples.
Assessment 1: FFO valuation
AMT generates stable cash flow thanks to its scale and centuries-old support. In the first quarter, its AFFO posted solid growth despite Sprint’s churn and schedule-related cash taxes and maintenance CAPEX headwinds. Consolidated AFFO per diluted share was $2.63, representing a year-over-year change of 4.4%.
Looking ahead, the company has a terrific model, fundamental economics, and centuries-old long-term support. It has a global presence and reach, with a portfolio of approximately 187,000 communication sites worldwide. ~99% of revenue is generated from rentals of properties in their global portfolio. And as 5G deployment accelerates, the value of its tower assets will become even more critical to 5G deployment. The company expects consistent rental trends in the remaining regions as 5G coverage and 4G densification drive demand across the global footprint.
Thanks to its scale and centuries-old backing, AMT has delivered superb returns and stable income to investors. AMT investors have been handsomely rewarded over the past decade through a combination of earnings growth and dividends. In terms of FFO multiples, as the following chart shows, AMT averaged 25.5x historically over the past few years when its exponential growth came to an end.
Thanks to its robust and stable earnings, the chart also shows that whenever the price falls near or below 25.5x FFO in recent years, it has been a good time to buy. And as you can see, now is such a time. The stock is valued at around 21.8x FW FFO, a discount of nearly 15%.
Assessment 2: Dividend discount model
The company maintains a stable balance sheet at an investment level. It just issued $1.3 billion of senior unsecured notes on attractive terms, just after the end of the first quarter. The proceeds will be used to extinguish a portion of our floating rate debt. As Executive Vice President and Chief Financial Officer Rod Smith commented (emphasis mine):
Finally, with respect to balance sheet management, following our recent issuance of senior unsecured notes, which I highlighted earlier, and pro forma for the execution of our equity financing, we will have issued a significant balance of our floating rate debt and we expect to provide our net leverage on 5x high range, with a clear path to return to our 3-5x target range over the next two years.
Given the stability of its balance sheet and capital structures, this analysis uses the weighted average cost of capital (“WACC”) as the cost of capital and discount rate. WACC is the average cost for a company to raise capital, i.e. equity and debt in the case of AMT. The average was taken by proportionally weighting the share of equity and debt. The WACC for AMT over the last decade is calculated and presented in the table below. As can be seen, it was quite stable in the range of 7.1% to 8.2%, with an average of 7.7%.
The chart also compares WACC to ROIC (return on invested capital) for AMT. As can be seen, ROIC has consistently outperformed WACC by a healthy margin. For a company like AMT, the ROIC calculation considers the following as invested capital: working capital (including accounts payable, accounts receivable, inventory) and total real estate assets.
With the WACC obtained above, we can now value the business and analyze potential returns using the discounted dividend model (“DDM”). As detailed in our previous article,
REITs are a good place to apply the discounted dividend model (“DDM”) because of their relatively stable earnings and the fact that they pay most of the income in the form of dividends. In the DDM model, the fair value of a company is the sum of all its future dividend payments discounted to their present value. And in this analysis, we will use the WACC as the discount rate.
The DDM calculations for AMT are shown below. These calculations took into account different combinations of WACC and Final Dividend Growth Rate (“DGR”). Because as we have seen above, the WACC has fluctuated and will fluctuate within a certain range. Many factors can cause such fluctuations, such as interest rates and the capital structure of the company. Therefore, it makes sense to explore a range of possibilities. These calculations also took into account a range of dividend growth rates at maturity, ranging from 4% to 7.5%.
Based on this DDM analysis, my projections are:
- As a base case, I expect the fair value to be around $285. The base case assumes an average WACC and an average growth rate.
- The bullish case considers a happy combination of higher growth rate and lower cost of capital. The expected price in this case will be around $350.
- The projected price in the bearish case is around $220 (representing an unlucky combination of higher cost of capital and lower growth rate).
As can be seen, for the base case, its current price is also around 15% off the target price, quite close to the FFO valuation shown above.
Conclusion and risks
The recent price correction has created an entry opportunity for AMT. It is attractively valued both in terms of FFO and dividend appreciation. Both approaches show that it is undervalued by about 15% of its fair value. And our bullish thesis is supported by both short-term and long-term catalysts. In the near term, it is well positioned for organic growth and EBITDA growth through its new additions of assets and services. In the long term, it is strategically positioned to capture incremental demand from global 4G and 5G rollout initiatives.
Finally, AMT also faces certain risks.
AMT faces a number of macroeconomic risks and uncertainties that are currently unfolding. Examples of these risks include its financing plan for the acquisition of CoreSite, the impacts of COVID-19 and interest rate uncertainties.
Particularly with regard to interest rates, the company carries a fairly high level of debt (like all REIT companies). Its current long-term debt is approximately $38 billion. Thus, a 1% increase in its interest rate would result in $380 million in additional interest expenses. Its FFO is approximately $4.8 billion in 2021. Therefore, additional interest charges represent approximately 8% of its FFO, a significant risk. Although the reality is more complicated and could be better or even worse than this simple estimate here. On the plus side, most AMT debt is well-staged. Thus, the effects of higher interest charges will be gradual and not abrupt to give management time to react and adapt.
But on the negative side, there is always the possibility that interest rates could rise more dramatically than the current Fed dot chart. And AMT must also continue to issue new debt to finance its new investments.