TBC - AT&T Q1 2023 Earnings: FCF Miss Just Blew Up Execution Risks
2023-04-20 10:50:25 ET
Summary
- AT&T reported mixed first quarter results, with a substantial FCF miss hitting a sore spot for the stock.
- AT&T's first quarter results highlighted challenges of ongoing deterioration in the consumer amid mounting macroeconomic uncertainties.
- Decelerating subscriptions, alongside a revenue miss, are weighing on confidence in management's reiterated guidance for generating $16 billion in FCF this year.
AT&T's stock (T) has repeatedly contested the $20-range over the past year since stepping away from its foray in media and entertainment, but struggled to sustain momentum above said levels. The observed trend continues to underscore AT&T's need to convince markets of its ability in sustaining free cash flow expansion - a critical factor for consideration among its income-focused investor base. Heading into first quarter earnings, investors were primarily focused on AT&T's progress towards generating $16 billion in guided free cash flow for the year, given ongoing uncertainties over the pace of looming macro deterioration as broader market sentiment and performance maintain a resilient rebound from the early-year financial sector crisis.
While AT&T's first quarter earnings were in line with expectations, partially offsetting slight disappointment in revenues, with management still reasonably optimistic about its current year guidance, the stock has not exhibited any outsized response on the subdued news, implying investors' cautious optimism given ongoing macroeconomic uncertainties. Looking ahead, we continue to stay incrementally cautious on the impact of looming recession risks over AT&T's demand environment, despite the mission critical role of connectivity services, as well as payment collection trends, as both factors remain core contributors to the company's $16 billion free cash flow guidance - a key focus area for investors - for the current year.
Overview of 1Q23 Performance
AT&T added 424,000 postpaid wireless mobility subscribers during the first quarter, decelerating from 656,000 in the prior period. Fiber net adds came in at 272,000, with total subscriptions now at 7.5 million. Revenue grew 1.4% y/y to $$30.1 billion, missing consensus calls for $30.3 billion. Earnings came in at $0.60 per share, which was largely in line with the average market forecast of $0.59 per share.
The performance metrics point to stark deceleration in demand during the first quarter, which is consistent with growing investor concerns over the impact of a looming recession and weakening consumer on AT&T's near-term fundamentals despite its provision of mission critical connectivity services. Despite record quarterly revenue growth of 5.2% y/y in the domestic wireless service segment and 30.7% y/y in the fiber segment, which implies ARPU expansion in the consumer-centric verticals, they were insufficient in compensating for growing signs of weakness in volumes. This is corroborated by disappointing free cash flows, which only totalled about $1 billion exiting the first quarter, missing the average expectation for $3 billion by a wide margin. This has accordingly dialled up investors' angst on the durability of management's reiterated guide for $16 billion in free cash flows by the end of the year, adding to execution risks ahead amid continued economic deterioration.
Macro Risks to Fundamentals are Ballooning
Retail sales for March declined for a second consecutive month by 1% y/y despite decelerating price increases in recent months. The data, paired with " emerging cracks in a strong labour market", among other signs of continued economic deterioration are pointing to elevated recession risks on the horizon.
Specifically, after a year of resilience in the labour market, job vacancies in the U.S. have fallen below 10 million for the first time in two years in March. The pace of hourly wage growth also decelerated at a consistent clip this year, potentially implying a gradual restoration in the balance of labour demand and supply, as the impact of job cuts in late 2022 and earlier this year - most prominently in the high-paying tech and financial sectors - continue to flow through the economy.
In addition to the pinch of persistent inflation, the anticipated continuation of weakness and potential declines in employment and income are likely to weigh on the consumer further over the near-term. This is further corroborated by a slowdown in consumer credit and debit card spending in March. While the accelerating uptrend in outstanding consumer debt earlier in the year had pointed to a growing reliance on credit cards to sustain spending, the recent slowdown, alongside a complementary retail sales decline, potentially implies that the taps are being tightened altogether, as inflationary pressures on savings are now being compounded by an anticipation for decreases in wages and income ahead. And these trends are becoming increasingly prominent after massive workforce reductions announced across some of the highest paying sectors - recent data shows "households that make more than $125,000 a year saw a drop in annual after-tax wages for the first time since May 2020", implying weakness among the more affluent that has largely been supporting consumption over the past year amid surging inflation.
This adds to a challenging demand environment for AT&T, among other operational considerations. Despite the relatively recession-resistant nature of AT&T's business, given the mission critical role of connectivity services, new customer acquisition could stay difficult in the near-term, while subscription retention will likely come at a higher cost as well, considering consumer price sensitivity and stiff competition in the industry. This is corroborated by continued deceleration in postpaid net adds during the first quarter, a trend that is likely to persist over coming months. Although AT&T has been diligent over the past year when it comes to managing subscription perks, we expect more aggressive discounts during seasonal promotions in the second half of the year to sustain market share gains and mitigate churn amid the weakening consumer, which harbingers risks to profit margins. Growing difficulty for American households to make payments for usual household expenses ahead of a looming recession could also lengthen collection cycles and encourage persistently high bad debt levels as observed in the fourth and first quarter.
Operating expenses were $24.1 billion, essentially stable with $24.2 billion in the year-ago quarter reflecting the benefits of our continued transformation efforts…[The] decreases were partly offset by higher amortization of deferred customer acquisition costs, higher bad debt expense and increased depreciation.
Source: AT&T 1Q23 Earnings Press Release
Mobility EBITDA was up about $740 million or more than 10% for the quarter, driven by growth in service revenues, transformation savings and the absence of 3G network shutdown costs versus the fourth quarter of 2021. This was partially offset by higher bad debt levels.
This would potentially impact AT&T's ability in achieving its free cash flow target for the year - a critical number to sustain annualized dividend payments of almost $8 billion ( $0.2775 quarterly per share for T at 5.6% yield; $0.3125 quarterly per share for T.PA at 5.7% yield; $0.2969 quarterly per share for T.PC at 5.7% yield), as well as $13.8 billion in debt due within one year alongside interest expenses.
The Bottom Line
Despite the stock's steady upsurge this year, AT&T's stock continues to trade below its historical average at just about 9x estimated free cash flows, and in line with peers including Verizon (VZ) which is expected to grow slower with less profit in the current year. But the lack of momentum after a subdued first quarter report continues to indicate investors' cautious optimism over AT&T's near-term performance. While the stock still yields attractive dividends at an annualized rate of about 5.6% at current levels, which is greater than long-dated Treasury , its range-bound valuation for now alongside subdued performance in the cost-intensive and macro-sensitive underlying business' fundamentals amid a looming recession implies shaky investor confidence in AT&T's near-term free cash flow strength.
The telecom giant likely has much work left to do to shore up investor confidence in its ability to unlock incremental value amid a recession-hampered ramp up of its fiber and 5G roll-outs in the near-term. While management maintains their commitment to achieving annualized cost reductions of $6 billion by the end of the year with ongoing implementation of aggressive operational streamlining efforts, which will help mitigate some of the macro-driven risks to free cash flows, we expect income-focused investors to remain in a "wait-and-see" stance over coming months as they mull on how macro conditions will play out before adding to their portfolios in order to prevent yield dilution and exposure to impacts of uncertain market conditions.
For further details see:
AT&T Q1 2023 Earnings: FCF Miss Just Blew Up Execution Risks