T - AT&T: Post-Earnings Surge Dissipated - Why It's Time To Pull The Buy Trigger

2023-10-24 12:30:00 ET

Summary

• AT&T's post-earnings surge last week was quickly reversed, leading to a selloff and catching late buyers off-guard.
• The pullback may provide investors with a more favorable risk/reward opportunity to add exposure to AT&T.
• Despite concerns about its topline growth and leverage ratio, the company's strong Q3 performance suggests that the worst may be over.
• I explain why this week's selloff is justified, as AT&T's growth normalization phase carries higher execution risks.
• Despite that, I argue why the risk/reward profile has improved with the selloff, providing a better opportunity for dip-buyers to buy more shares.

What a week for AT&T ( T ) investors, as its post-earnings surge last week was quickly digested by astute sellers. Accordingly, AT&T reported its third-quarter or FQ3 earnings on October 19, as management upgraded its FY23 free cash flow or FCF and adjusted EBITDA guidance.

As such, it led to a momentum spike and a bull trap (false upside breakout), as astute AT&T sellers forced a selloff at the $16 level, stemming further upside. Accordingly, T has fallen below the lows of its post-earnings surge, catching last week's late buyers off-guard as they turned bullish at the worst possible moment.

With T inching closer to its early October lows, I believe it's opportune to update investors about whether the pullback this week provides a more favorable risk/reward opportunity to add exposure.

I last updated AT&T holders in late August, urging them "not to lose sight of the prize." As the market was still relatively pessimistic then, I gleaned that it was timely to buy more shares, as T's price action turned more constructive.

As such, I'm increasingly confident that T struck its long-term bottom in July 2023, as investors fled to the hills following the Wall Street Journal's disclosure of its lead-sheathed cables challenges. However, that capitulation also led to a sharp bullish reversal, attracting high-conviction dip-buyers confident that the fears were overstated.

Moreover, AT&T posted a solid Q3 earnings scorecard bolstered by a solid growth momentum in the consumer business. Accordingly, AT&T delivered a 9.8% growth in its consumer broadband business, supported by its Fiber revenue increase of nearly 27%.

In addition, AT&T also garnered a 3.7% increase in wireless service revenue while posting robust postpaid net adds of 468K, up from 326K in Q2. As such, the resilience in its consumer business has likely given management confidence to upgrade its FY23 FCF guidance to $16.5B. The company also revised its adjusted EBITDA growth outlook upward to "at least 4%."

The company's strong performance has given me more confidence that we have likely seen the worst in T's most significant battering in years, as it bottomed out in July 2023.

Despite that, last week's bull trap suggests dip buyers weren't keen to maintain their exposure, using momentum spikes as opportunities to take profit. However, considering T's nearly 13% surge from its early October lows through last week's highs in price-performance terms, I believe the selling is justified. Why?

Although AT&T is embarking on a more profitable growth phase as it aims to improve the quality of its customers, it could also affect its topline growth. Seeking Alpha's "D-" growth grade corroborates my concerns. While the company's best-in-class "A+" profitability grade should help defend against its competitive advantage, AT&T remains in the investment phase.

Analysts' estimates suggest that AT&T's CapEx spending could slow to $18.3B in 2024 before decelerating to $18.1B by 2025. However, it still represents nearly 15% of its FY25 estimated revenue, suggesting that spending remains elevated. Although management is confident that its FCF profile is expected to improve further, given the lower CapEx effect, it's under pressure to further reduce its adjusted EBITDA leverage ratio.

As such, with a much slower topline growth, I still expect T to be placed in the penalty box as investors assess its ability to reduce its leverage ratio to 2.5x by FY25 while mitigating the higher cost of capital as part of its CapEx buildout. In other words, I expect T to remain relatively undervalued, as execution risks are expected to remain elevated.

As seen above, T formed its July 2023 lows at the $13.5 level and hasn't looked back.

I gleaned that its buying sentiments have improved over the past three months as T buyers attempt to regain control of its short-term uptrend.

Last week's bull trap at the $16 level has likely digested some near-term buying optimism, helping to improve the risk/reward for dip buyers looking to add.

Despite that, I must highlight there's no price action validation of an optimal entry zone. However, I expect T's October lows ($14 level) to hold if the uptrend recovery thesis remains intact. I will revisit my thesis if that level is breached decisively by intense selling pressure.

Rating: Maintain Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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