TBC - AT&T: Buy Alert

2023-10-28 12:00:00 ET

Summary

• AT&T's Q3 performance exceeded expectations, showing that fears about the company were overblown.
• The expansion of AT&T's 5G and fiber networks will contribute to future growth and profitability.
• Despite high debt, AT&T's strong performance and increased guidance make it a good dividend and value play.

AT&T ( T ) remains a great value pick as the company’s successful performance in Q3 shows that most of the fears have been overblown and the business is likely to create additional shareholder value in the following quarters. Considering that AT&T has also increased its guidance for FY23, it’s safe to say that there’s nothing not to like about the company at this stage despite all the macroeconomic challenges that it currently faces.

AT&T Silences The Naysayers

Back in August, when the pessimism about AT&T’s stock was at its peak, I stated that most of the fears that prompted investors to look for alternative telecom names had been overblown as the company back then had everything going for it to show a solid performance in the following quarters.

That’s exactly what has happened as AT&T’s recent earnings report for Q3, which was released last week, showed that the business has exceeded the street expectations and the management delivered on its promises. In Q3, AT&T’s revenues were up 1% Y/Y to $30.35 billion, above the estimates by $110 million, while its non-GAAP EPS of $0.64 was above the estimates by $0.02. At the same time, AT&T managed to add 468,000 postpaid phone users, also above the estimates of 430,000, while the churn rate during the period was only 0.79%, an improvement from 0.84% a year ago.

Going forward, it’s safe to assume that AT&T’s growth story won’t end anytime soon. One of the major things that AT&T is currently doing is the expansion of its 5G and fiber networks, which should result in the growth of its revenues and profits in the long run. Its fiber ARPU in Q3 was already up nearly 9% Y/Y and the company is now on track to surpass 30 million fiber locations by the end of 2025, as it already had 24 million locations at the end of Q3. At the same time, AT&T would also be able to accelerate the pace of expansion in the next two years thanks to its joint venture with BlackRock and due to the allocation of federal funds via the BEAD program. As such, it’s safe to say that there’s nothing not to like about the company at this stage.

Another important point that needs to be mentioned is that the dividends are unlikely to be cut or fully eliminated anytime soon despite the company’s current high debt load. This is due to the fact that AT&T exceeded expectations and managed to generate $5.2 billion in FCF in Q3. Thanks to such a great performance during the quarter, the management has even raised its outlook for the year and now expects the business to generate $16.5 billion in FCF in FY23, above the previous expectations of $16 billion. Considering this, it’s safe to say that AT&T is also a decent dividend play at this stage, as its stock offers a yield of over 7% at the current price while the major risks have also subsided.

In addition to all of this, it’s safe to say that AT&T’s stock is also undervalued at the current price as it trades at ~6 times its forward earnings, which is below the sector median forward P/E of ~13x. At the same time, the street believes that AT&T’s shares offer a ~24% upside at the current price, while my DCF model from May showed that the company’s fair value is $20.37 per share. Considering that the assumptions in that model mostly align with the current updated street estimates , it makes sense to believe that AT&T’s fair value is indeed somewhere around the $20 per share range which indicates that the stock is undervalued right now.

Risks

There are several risks that investors need to understand before deciding whether it makes sense for them to go long AT&T at the current price. The biggest risk, which is also outside of the company’s control, is the worsening macro environment that has the potential to slow down AT&T’s growth. The inflation has once again started to pick up M/M in recent months and considering that rates are more than likely to stay higher for longer, this new environment creates several major challenges for the company and its balance sheet.

At this stage, AT&T’s major downside is without a doubt its excessive debt load. At the end of Q3, the company had $126.7 billion in long-term debt and only $7.5 billion in cash reserves. The good thing about this is that AT&T has an interest rate coverage of nearly 4x which indicates that it earns more than enough cash each quarter to cover its debt-related expenses, pay the dividends, and reinvest a portion of funds back into the business. At the same time, all that debt is partitioned into smaller portions with maturity dates spread out all the way until the end of the current century.

While this ensures that AT&T won’t be forced to look for additional liquidity anytime soon, the problem is that as the debt slowly nears the maturity date and the company decides to refinance it, it would certainly be prompted to pay higher rates on the newly issued debt. This would result in a rise in its interest expenses each quarter which would hurt its bottom-line performance.

Even though this is not an immediate problem at this stage, it will certainly become an issue in the future and could even prompt the management to cut later in the decade so that the debt is serviced on time. This is something that investors need to keep in mind before deciding whether to invest in AT&T.

The Bottom Line

Even though the debt issue will continue to haunt AT&T for decades to come, especially if the rates stay higher for longer, there are nevertheless reasons to believe that the company would be able to mitigate most of the risks in the foreseeable future. We already see that there are more than enough growth catalysts that could help AT&T’s business continue to generate decent returns and reward its shareholders at the same time. In addition to that, the latest successful performance in Q3 along with an increased guidance indicate that most of the fears were mostly overblown and AT&T remains to be a great value pick at the current price.

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