TBC - AT&T: Time To Go All In

2023-07-31 14:45:25 ET

Summary

• AT&T reported good earnings results for Q2.
• The management has once again reiterated its commitment to generate $16 billion in FCF this year.
• If that goal is achieved, then both the dividends and the debt payments will be fully covered, while the stock could appreciate further.

Recently, AT&T ( T ) reported good earnings results for Q2 which showed that the company’s core business is growing while the management is on track to reach the goal of generating $16 billion in FCF this year. Even though earlier this year there were concerns about whether the company would be able to meet its targets, which are crucial in order for AT&T to pay the dividends and cover the debt payments, it seems that those concerns have been eased now after the latest report. Therefore, as AT&T’s business continues to grow and generate decent returns, the current market price of the company’s stock could represent a great buying opportunity for value investors since it seems that most of the major risks have been mitigated so far.

Q2 Has Been A Success

The Q2 earnings results that were revealed a few days ago showed that AT&T’s revenues during the period increased by 0.9% Y/Y to $29.9 billion, while its operating income was up 29.3% Y/Y to $6.4 billion. At the same time, the company’s cash from operating activities increased by 28.2% Y/Y to $9.9 billion during the quarter and the management has once again reiterated its commitment to generate $16 billion in FCF this year, which would fully cover the dividend and debt payments in FY23. So far, AT&T already generated $5.2 billion in FCF YTD, and considering that historically most of the FCF has been generated in Q4, there are reasons to believe that that goal is more than achievable, especially after the recent reassurance from the management during the latest earnings call .

In addition to that, it’s good to see that AT&T’s core business continues to grow even in the current challenging environment. During the latest quarter, the company added an additional 251,000 subscribers to its fiber internet service, while the average fiber ARPU increased by 8.2% to $66.70. Thanks to such a performance, it’s likely that AT&T would be able to achieve its goal to reach 30 million or more fiber locations by the end of 2025 at the current growth rate, especially since the latest joint venture with BlackRock (BLK) alone could add at least around 1.5 million additional locations in the following years.

What’s more is that AT&T is likely to have access to additional federal funds via the BEAD program in the next few years, which would help it to expand its network even more to underserved areas using taxpayers' resources. This won’t be the first time when AT&T received outside funds to expand its network. Since 2021, it has used a portion of funds from the American Rescue Plan Act to expand its network to over 130,000 customer locations, and it would be able to do the same thing with BEAD funding without using much of its own funds to grow its business.

On top of all of this, it’s also important to note that all the fears about the potential damages that AT&T could face due to the use of decade-old lead-clad cables, which brought its stock to multi-decade lows in recent weeks, appear to be overblown. In a response to the recent WSJ investigation , AT&T stated that lead-clad cables represent only a small part of its network, while the street analysts believe that the overall costs to clean up those potentially hazardous cables could be insignificant considering how much the overall business generates in a quarter.

Therefore, it makes sense to justify the street’s consensus price target for AT&T of $19.86 per share, which represents an upside of nearly 40%. Back in May, my DCF model showed the company’s fair value to be $20.37 per share, and considering that the expectations for the year haven’t changed significantly, I believe it makes sense to believe that the upside remains significant.

Debt Would Remain The Only Major Headwind For Decades Ahead

Even though AT&T’s stock is undervalued based solely on the fundamentals, investors nevertheless need to acknowledge the debt risks that are associated with the company before deciding whether to accumulate a position at this stage. While the U.S. economy has been resilient in recent quarters, there’s a possibility that the higher rates could stay with us for a while. In such a scenario, it would be crucial for AT&T to keep its debt load in check, as it has no room for error after the Time Warner fiasco that bloated its balance sheet.

On the one hand, AT&T’s debt situation is manageable for now. The company has an interest coverage of almost 4x, it expects to cut its net debt by $4 billion in 2023 which would help it to end the year with a net debt to EBITDA ratio of 3x, and its maturities are spread out until the end of the current century . If it manages to reach its FCF goal this year, then both the dividends and debt payments will be covered with ease.

However, as debt maturities roll over, it would become a problem for AT&T to refinance them at an attractive rate if the Fed sticks with a tight monetary policy for longer than anticipated. If that happens, then the company could be prompted to sacrifice dividend payments in the future in order to ensure that the debt situation remains manageable. While this is unlikely to happen anytime soon if the FCF target for 2023 is achieved, it could very well become a realistic scenario in the years ahead.

The Bottom Line

Considering all of this, AT&T is on track to show a decent performance in 2023 despite all the challenges that it faced in recent months. While a high debt load would continue to haunt the company for decades to come, it would be safe to assume that at least for now the dividends are safe while the business’s growth story is not over yet. As such, AT&T’s current market price might offer a great buying opportunity for value investors, since it seems that most of the major risks have been mitigated so far.

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