AT&T Stock: Boiling Alive

Summary:

• After AT&T’s 10% post-earnings sell-off, analysts are split into FCF recovery believers and non-believers.
• As I mentioned in my Q4/22 earnings review, management had actually hinted to some issues with FCF.
• Yet even with a FCF recovery later in 2023, the key problem with AT&T still remains the same.
• AT&T remains an unattractive Hold, a short-term Buy and a long-term Sell.

T Stock Key Metrics

AT&T (NYSE:T) has been a disappointing stock for long-term investors, to say the least.

	2013	2022
Normalized net income	$16.9B	$13.8B
Normalized EPS	$3.14	$1.92
DPS	$1.81	$1.11
Diluted shares outstanding	5.4B	7.2B
Net debt	$72B	$160.6B

Click to enlarge

(Source: Seeking Alpha)

Net income and dividends have declined, dilution was massive and net debt has skyrocketed.

Today, it trades for $18.22 per share, has a market cap of $130B and sports a 6% dividend yield. Based on expected 2023 results, the P/E ratio is 7.5.

The stock trades 20% below its 52-week high and 26% above its 52-week low, therefore, despite the feel of a panic, it is actually trading quite precisely in the middle of its recent range.

When compared to its 2013 share price of ~$28, there is not much valuation change either: Shares are down just as much as earnings and dividends.

With the benefit of hindsight we have to say, however, that in 2013 the stock was terribly overvalued. The question is whether it is more fairly valued today.

What Were AT&T’s Expected Earnings?

The usual game around earnings is obviously of the short-term kind: Management telegraphs its expectations to the sell-side, closely follows the development of consensus estimates and tries to deliver a small beat.

Hence, the sell-side expected adj. EPS of $0.59, while actual Q1/23 results came in one cent higher. Revenues, in contrast, came in a tiny 0.2% below expectations.

This goes on quarter after quarter. On this Seeking Alpha overview you can see that over the past four years AT&T has almost never delivered a “miss”, yet – even adjusted for the WBD (WBD) split-off – the stock is down ~30% over the same time.

Over the long term, at least in the case of AT&T, this reminds me of the apologue of the slowly boiling frog: “Beat” after “beat”, investors were boiled alive.

Did AT&T Beat Earnings?

Technically, Q1/23 results probably qualify as a beat. Yet the stock sold off 10% and only timidly bounced 3% the day after.

The usual explanation refers to disappointing free cash flow, which, after excluding the DirecTV contribution in the quarter, actually came in negative. Management reiterated its confidence in the full-year $16B FCF guidance and explained that, as telegraphed one quarter ago, this quarter included several “one-time items”: high device payments after the holiday quarter (the price to pay for high phone net-adds), relatively high capex, annual incentives.

All this probably does not justify a 10% sell-off.

Another explanation for the sell-off refers to the higher debt load despite headline FCF generation, as compared to nine months ago. In theory $11B of “free” cash has been generated, but net debt was still $2.7B higher. Again, management reiterated that net debt will come down over the coming quarters.

The Elephant In The Room

Three months ago, after the Q4/22 release I wrote a provocative article called “Why AT&T should cut its dividend“. In extreme synthesis, my thesis was that growth opportunities exist, but they cost money and AT&T will lose to cash-rich peers like T-Mobile (TMUS) if it does not free massive amounts of money now.

Predictably, the article did not receive much acclaim. The stock had just rallied 6%, as investors were supposedly relieved after a better-than-feared 2023 guidance. (Remember the frog.)

But actually, as I mentioned in my article, management had provided some indication that it was not that confident in its FCF generation and/or debt reduction goals, as it almost halved its fiber build rate – despite having announced much higher targets very recently and despite acknowledging that the fiber “land rush” was one of its most important growth opportunities.

Additionally, during the Q1/23 earnings call, there was a lengthy exchange about a potential combination of DTV with DISH (DISH) and/or the acquisition of spectrum assets from DISH. John Stankey did not really provide a clear answer, but the spectre of another huge M&A transaction suddenly rose from the horizon.

– So what is the elephant in the room? Is this really about $1B or $2B of FCF more or less in a single quarter, which might or might not come back a few quarters later? – I don’t think so.

The real elephant in the room is capital allocation.

If AT&T continues to pay out $8B of dividends and simply matches its $4.6B D&A charges with capital expenditures, there is not much room for growth and debt reduction left, even assuming $16B of annual FCF.

But dividends are expected to grow a tiny bit every year, inflation increases capex requirements, and higher interest rates add to the cost of debt.

In this quandary, what is AT&T doing? – So far it has basically acquired growth by heavily subsidizing customer acquisitions. But this reduced FCF. As a consequence, fiber build rates were reduced. But this will reduce future growth. The next step will likely be less subsidies (meaning less near-term growth), continued slower fiber build (less long-term growth), but higher FCF and less net debt. When investors start to complain about growth rates, M&A will be discussed, fiber builds will accelerate or phone subsidies will grow again (net debt and/or share count will increase).

You can dip a toe in, pull it out again, dip an arm in, pull it out, dip instead a leg in – over the long term it does not really matter: Piece after piece, the frog will be boiled.

What To Expect After Earnings

Management was actually honest about that – and I fully agree: More of the same. (Although my interpretation of this statement is probably different from AT&T’s.)

From what I’m reading and hearing, on the investor front there is not much news either: The focus is squarely on the near-term trading activity related to earnings results. The battle is between those that believe management projections and those that don’t.

As we have seen, this actually fits the usual Wall St game plan perfectly. Somebody will always own the shares – if they trade frequently, so much the better. Over the long term – who cares.

We will see the rest of the pack, too: Verizon (VZ), T-Mobile and the cable companies will report results shortly. But for AT&T investors they won’t really matter. The company’s flexibility is constrained. And if it attempted to break out by engaging in some large “transformative” transaction, it would be even worse, as nobody trusts its capital allocation process.

Is T Stock A Buy, Sell, Or Hold After Earnings?

AT&T remains an unattractive Hold, a short-term Buy and a long-term Sell.

It is an unattractive Hold, because Treasury Bills give you a yield which is only ~1% lower than AT&T’s, while safeguarding principal. Higher, relatively safe yields are available, too. Sure, Treasury yields won’t increase, instead AT&T dividends will. But growing dividends are indirectly responsible for an increase in net debt and/or share count and/or lower future growth. Which means the share price will likely move lower over time.

It is a short-term Buy for traders that don’t care about the long-term, when the stock moves closer to the bottom of its trading range. Investors will lose their minds (and their shirts) about short-term implications and explanations of earnings releases. Release after release, the water temperature is rising slowly, but the frog is still happily bathing. Three months from now, a better-than-feared FCF figure coupled with lower net debt might make the stock fly.

However, over the long term, the trading range will likely move lower. While I hope the species of long-term investors has gone extinct in AT&T, I still notice that some are fatally attracted to the warm water. You will experience earnings beat after earnings beat in an increasingly unpleasant temperature, and the longer you stay, the less likely you will be able to escape. This is why you should sell as soon as you can.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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