AT&T Drops Again, We Recommend Investing Again

Justin Sullivan

AT&T (NYSE:T) has struggled to generate shareholder returns. The company is sitting at a $135 billion market capitalization, moving from a focus on massive share buybacks a few years ago, to spin-offs and a reduced dividend. The company has, in our view, a steady path forward but it needs to focus on execution. Despite management’s mistakes, we see the company as a good investment.

AT&T Business Priorities

AT&T has continued to focus on achieving its business priorities with a long-term focus on shareholder returns.

AT&T Investor Presentation

AT&T Business Priorities – AT&T Investor Presentation

The company had an incredibly strong quarter in terms of customer relations. It managed to 800+ thousand postpaid phone net adds in 2Q 2022, up year-over-year. The company did have to utilize discounts to accomplish that, however, despite that, its overall margins have remained strong and its revenue increased.

The company’s fiber business, one that we’ve long been a fan of, saw more than 300 thousand net adds with improved market penetration rates. We’ve long talked about how the company’s opportunity here lied at the intersection of increased penetration in existing markets and new customer access and the company has shown a good job of accomplishing that.

The company is on track to achieve its cost-reduction goals despite continued inflationary impacts.

AT&T Quarterly Financials

Financially, the company had disappointing FCF, however, overall performance was strong.

AT&T Investor Presentation

AT&T grew its comparable revenue by 2% YoY; however, headline figure went down. The overall quarter was a bit of a mess due to divestments. The company’s standalone EPS did increase slightly YoY along with the company’s margins supporting returns. The company’s annualized EPS is well within the single digits.

The company’s cash from operations dropped significantly to $7.7 billion in the quarter. That combined with massive capital expenditures for the company of $4.9 billion with an astounding $6.7 billion in capital investment supported by vendor financing payments. The company has decreased its guidance from $16 billion to $14 billion in FCF for the year.

At the current market cap that’s still an 11% FCF yield. However, customer growth has led to an increase in the company’s wireless revenue.

AT&T Guidance

The company’s guidance still points to the potential for substantial earnings, although rising interest rates could potentially derail that.

AT&T Investor Presentation

The company’s largest guidance change, despite wireless service revenue growth, is for a $2 billion decline in FCF. However, the company is still guiding for 2023 guidance of roughly $20 billion. That’s a roughly 15% FCF yield in 2023. There’s substantial volatility that the company sees in the market which could hurt its ability to hit that guidance.

The company is clearly doing well in maintaining its existing mobility business and we’d like to see the company continue to grow its exciting fiber business.

AT&T Shareholder Returns

AT&T has several avenues it can use to continue generating substantial shareholder returns. 2022 represents a massive transition year for the company as it completes spin-offs, but we expect overall returns to be strong.

The company’s current dividend yield is 6%. That’s just under $8 billion annually. That means the company has $6 billion leftover in this year (a transition year) which should grow towards roughly $12 billion next year. That’s substantial additional FCF yield for the company, cash that it can use in a variety of ways.

The company still has more than $100 billion in long-term debt after paying down a substantial portion with the money raised from the TimeWarner spin-off. That costs the company billions in annual interest. We’d like to see the company aggressively pay down debt, not because it can’t afford it but because the market is punishing it for having that debt.

The company had an aggressive share repurchase program that it cancelled as a result of COVID-19. In a limited way this could also help reduce shareholder rewards and save on interest payments. Regardless of how the company spends the cash we expect strong shareholder rewards over time, although with volatility.

Thesis Risk

The largest risk to our thesis is competition. The company is in a capitally intensive business competing with Verizon and T-Mobile both of which have performed well. Dish could soon be a new competitor for the company. All of this competition was seen in the $10s of billions spent on recent spectrum sales. Best case additional capital spending is required, but regardless the company will need to perform.

Conclusion

AT&T is generating a double-digit FCF yield in 2022 and that’s expected to grow into a 15% FCF yield in 2023. The company recently paid off $40 billion in debt, however, it still has a substantial amount of debt that’s costing the company billions in annual interest expenditures. We’d like to see the company rapidly pay down that debt.

Regardless of how the company pays down its debt, as long as it continues to generate reliable cash flow, we expect the company to remain a valuable investment. Debt paybacks or share buybacks can both help generate substantial shareholder returns. That cash flow helps make AT&T a valuable investment.