AT&T: The End Is Nigh

Summary:

• AT&T Inc. stock is in a big-time downtrend, but we recently started buying heavily.
• The Q2 report was mixed, as some add metrics for subs missed estimates while revenue was about in line, but cost savings initiatives paid off and led to a beat.
• AT&T offers strong cash flow and a safe dividend.
• Outlook for the year should attract income investors.
• The end of this wave lower is near.

AT&T Inc. (NYSE:T) is quickly becoming a battleground stock, with ardent bears and income seeking bulls battling it out on article after article. The stock has been in a downtrend, and we recently took advantage of the dip into the mid-teens and sub $14. Our service made a nice rebound trade there, but shares are now falling again after the just reported earnings. We think the end of the downtrend is approaching, and expect the base of support is the $13-14 line. At that point, the income level is too attractive to pass up.

There is likely capital gain potential here, too, on a trade, but income-thirsty investors can buy up a near 8% yield at those levels. The just-reported Q2 earnings release shows business chugging along; there were some surprises here, and some notable strengths and weaknesses. The quarter was mixed overall.

Shares are down a bit as the Street tries to digest the quarter and the outlook. When buying for income, our main concern is that the AT&T Inc. dividend is covered by free cash flow, and trends in the large debt burden. We recently discussed our expectations for Q2, so let’s check in on the numbers. We continue to rate shares a buy, but we are cautious on the market for the next few months. Let us discuss.

AT&T Q2 results in context

Markets are searching for direction at these recent highs, and all eyes have been on guidance. So far, earnings remain strong, but outlooks have been mixed. For AT&T, it is slowly seeing its financial position improve, while investing in the future. The main medium-term concern we see is that if the consumer does weaken, telecoms will be stepping up their promotional activity even more to attract and retain customers and revenues can be hit.

AT&T reports a Q2 revenue “miss” again

Overall, our revenue expectations for AT&T Inc.’s Q2 2023 were slightly more conservative relative to consensus. Analysts covering the company were targeting a consensus of $29.95 billion. We expected revenue to be right at $29.75-$30.15 billion in revenues, this was a “miss” of $30 million but right about in line with our expectations as revenue of $29.92 billion were right at the midpoint.

AT&T Q2 revenue drivers

Wireless postpaid growth saw 0.464 million adds, and these continue to be boosted by 5G availability as well as promotions put into place during the quarter. AT&T also reported 0.272 million fiber net adds, which surpassed our estimate of 0.251 million fiber net adds. Both of these results are strong, and postpaid adds continue to grow nicely while the fiber add result now marks the 14th straight quarter of 0.2 million adds or more. Consumer wireless service revenues were up 2.4%, and they had strong mobility operational performance. Business wireline revenues, however, were down 5.6%. Overall, the results were mixed.

AT&T Q2 bottom line earnings

So, the roughly in-line top line performance, which grew 0.9%, helped drive the bottom line to a beat versus consensus in conjunction with cost savings measures. Recall, AT&T is on pace to see $6 billion in run-rate cost savings before the end of the year. That said, analysts were looking for $0.60, and this was surpassed by $0.03. We were more bullish as our target range was $0.60-$0.65, so this result was at the higher end of our more bullish range. Operating expenses were $23.5 billion, down 4.8% from a year ago, and down 2% from the sequential quarter. Operating income grew from last year to $6.4 billion, up $1.4 billion from a year ago, and up $400 million from the sequential quarter. This is a solid result, and the Street should start to pick up on these improvements.

For the dividend, it is all about cash flow, as we preach. As you know, we think free cash flow is critical.

AT&T Q2 cash flow easily covers dividend

Free cash flow is critical to covering the dividend payment. We targeted Q2 free cash flow around $2.0-$3.0 billion. Free cash flow was well above our expectations and hit $4.2 billion. We were off on our expectations, as cash from operating activities was $9.9 billion, a huge increase, and capex was $4.3 billion, while cash for vendor financing was $1.6 billion ($0.5 billion less than Q1). With dividends paid of $2.01 billion, the payout ratio was less than 50%. For the year, the payout ratio is still projected to be in the 60% range, so free cash flow will cover the dividend easily all year.

AT&T’s debt

Over the last three years, management has been improving the balance sheet by selling off assets and paying down its debt. Over $20 billion in debt has been reduced in the last few years. The net debt was $134.2 billion to start Q2, and they ended with $132.0 billion of net debt considering cash. The net debt-to-adjusted EBITDA was 3.2X. That said, the company anticipates in the next two years it will reduce this ratio down to 2.5x.

Final thoughts on AT&T Q2

The Q2 report was mixed as some add metrics for subs missed estimates, while revenue was about in line but cost savings initiatives paid off and led to a beat on earnings. This is very positive. Operating income was strong and we think the Street picks up on this. We think the end of the downtrend is near. The debt took continues to be addressed. The dividend was easily covered by strong cash flow and for the year will easily be covered. This should attract more income thirsty investors, followings a Q1 where cash flow was weak.

As we look ahead to 2023, we see revenue growing 3%-4% on better pricing and more customer adds. We still see earnings coming in around $2.40-$2.55 for the year. That puts T shares at about 6X FWD EPS, which is very attractive. We rate AT&T Inc. shares a buy.

Your opinion matters

Do you like the name for income? Have a better name for income to recommend? Do you see the stock bottoming? Do you sell covered calls for added income? Do you trade around the core position like we do? We think the end of the downtrend is nigh, do you? Let the community know below.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of T either through stock ownership, options, or other derivatives. 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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