TBC - AT&T Q3 Earnings: Just Stop The Dividend Madness

2023-10-19 10:30:44 ET

Summary

• We laid out our AT&T expectations for all to see.
• AT&T Q3 revenues exceeded most expectations but came up short in other areas.
• We discuss the idea of a dividend cut.
• Can we get leverage lower?

As we all know, markets have quietly been pretty mixed since August. We have a seen a slow decline over the last two months that has brought your average stock to being down on the year. The market averages have really only held up on the back of the "magnificent seven," but even they are showing signs of pain.

One stock that we have been buying at these levels is AT&T Inc. ( T ), and we have updated you along the way of why we like telecoms at these levels. Earlier this month we gave you a preview of what we were looking for. Seemingly, the media took our phrasing of "all about cash flows" and ran with it. The purpose of this column is to assess our buy call in light of the just-reported earnings and compare the results to our projections.

AT&T Q3 Top Line

We were first looking for $29.95 billion to $30.30 billion in revenues in Q3. This was because any boost from the new iPhone will have started to hit at the end of Q3, so there could have been some small boost there. We still maintain that investors should largely expect a seasonal Q4 bump from those sales. Well, revenue came in at the highest end of the range, just over $30.3 billion. This was a tremendous result.

It all starts with that revenue target. Back in Q2, analysts covering the company were targeting a consensus of $29.95 billion, and this was a miss of $30 million, with revenue of $29.92 billion right at the midpoint. For Q3, consensus was $30.25 billion, so this was also surpassed.

Subscriber adds

In Q2, we saw wireless postpaid growth saw 0.464 million adds. We were looking for 0.450 million adds in Q3. AT&T also reported 0.272 million fiber net adds in Q2, and we were looking for 0.260 million in Q3. Well, total phone net adds (postpaid and prepaid) were 494,000, so this also surpassed our expectations. Postpaid subscriber net adds were 550,000, with phone net adds of 468,000, ahead of our estimate. This also helped drive the revenue number higher. Prepaid subscriber net adds were 56,000, with phone net adds of 26,000, which was below our estimate by 4,000, but essentially in line.

One positive is that postpaid phone-only ARPU increased 0.6%versus the year-earlier quarter. Finally, in business we were expecting a decline of 6-8%, and revenues were down 7.9%, largely due to businesses simplifying their plans

Operating expenses and earnings

We were assuming operational expenses that similar to Q2, and we expected earnings of $0.62-$0.66 per share. First operating expenses were $24.6 billion, up 2.2% from last year. There were some restructuring charges and continued inflationary cost increases, as well as higher network costs, and increased depreciation expense. Operating income was $5.8 billion compared to $6.0 billion in the comparable 2022 period, a bit below our expectations. Still, net income came right at the heart of our call, hitting $0.64, exactly in line with our midpoint estimate, and beating consensus by $0.02. That is a win.

All about cash flow

We said very plainly and got into it with some of the readers on our pieces that it was all about cash flow. If cash flow was strong, the stock would move higher, and vice versa. Shares are up over 4% premarket at the time of this writing. We expect a nice rally into the end of the year on the results.

Cash flow was strong in Q3. It is the most critical indicator we watch for with the telecoms, and now more than ever has an impact so much of this stock's trading behavior. When cash flow numbers are strong, confidence in the dividend is renewed. It is as simple as that. Back in Q2, free cash flow hit $4.2 billion and for Q3, saw "very positive dividend coverage" as likely. We stated

"Assuming cash from operating activities of $8.75-9.0 billion, capex of $4.0-4.5 billion, and unknown estimates for additional financing, we are targeting free cash flow of $4.6-$4.9 billion conservatively. This would be essentially full coverage of the dividend payments of $2.1 billion, which would be a 44% payout ratio. 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. The dividend is safe."

So how was that call? Well the actual cash from operating activities was higher than expected on better than expected revenues and hit $10.3 billion, reflecting operational growth and timing of working capital, including lower device payments partially offset by lower receivable sales. CAPEX was $4.6 billion also a touch above range, and when including $1.0 billion cash paid for vendor financing (which is always a wild card), capital investment was $5.6 billion. Because the top line was stronger than expected and expenses were well managed, it trickled down to cash flow. We were conservative in our estimate for $4.9 billion.

Well, AT&T generated free cash of $5.2 billion during the quarter, up $1.3 billion compared to the year-ago quarter. Free cash flow is up $2 billion more so far in 2023 than 2022. And with the latest dividend payment, we saw another sub 50% payout ratio this quarter. With $2.1 billion in dividends paid the ratio was 40%. Folks, the dividend is likely not getting cut. It appears secure.

The debt

We also said we would watch the massive debt burden. Over $20 billion in debt has been reduced in the last few years by the company. We started Q3 with $132.0 billion of net debt considering cash. The net debt-to-adjusted EBITDA still remains around 3.2X. We expected debt to dip to $130 billion in Q3. Total long-term debt was $126.7 billion to end the quarter, so added progress was made here. However, by 2025 AT&T should knock this leverage down well under 3.0X, with a goal of 2.5X

Final thoughts

We took a risk after being short AT&T and flipped to long with a strong buy conviction as shares dipped under $15. So far, that is still where they are, but the market is down much more, and a few dividends have been paid. We love the 7% secure yield here.

Your voice matters

Do you generate extra income from your holdings like we do at our service? Do you employ options? Do you trade around the core position? Are you a buy and hold forever investor? Do you see more downside ahead? Would you rather watch paint dry than own this stock? Let the community know below.

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