TBC - AT&T: You Were Warned

2023-04-20 10:15:42 ET

Summary

• A few weeks ago, we offered an AT&T Inc. earnings preview and suggested taking some profit on any meaningful bounce, and the stock did offer an opportunity at $20.
• AT&T Inc. Q1 earnings were mixed.
• Free cash flow metrics are key to the dividend, and this came in much lower than expected.
• There has been progress on the debt, but it took a bump higher this quarter.

AT&T Inc. (NYSE: T ) continues to be a name we own, and it just reported earnings . However, a few weeks ago we issued a cautionary tale and suggested selling a chunk of your position before the market started rolling over. We believe that process will start to unfold in the coming weeks. We are now in earnings season, and this is one catalyst we believe will help trigger the next leg lower in the market. The bottom line is that we believe earnings estimates as a whole will be coming down further, and the market will revalue lower. We are still at S&P 500 Futures (SPX) 4150 and we are well over 18X earnings, which is very expensive and will be getting more expensive if and when earnings estimates fall.

Turning to AT&T, we suggested selling as shares approached $20. Not to sell all of the position. But to take a chunk off and reinvest at lower prices. As of now, shares are down 8% on earnings. There were some surprises here, and some notable strengths and weaknesses. The quarter was mixed. Shares are down as the Street tries to digest the quarter and the outlook.

Our main concern is that the AT&T Inc. dividend is covered by free cash flow, and debt is coming down. But we are negative on the market the next few months. Let us discuss.

AT&T Q1 results in context

This earnings season is critical, as the markets are looking for direction as they have been pinned in a range the last few weeks. We just do not see meaningful upside much past 4200 on the SPX, and think risk-reward is imbalanced here. That said, the company is slowly seeing its financial position improve, while investing in the future. However, we do believe telecoms will be stepping up their promotional activity to attract and retain customers. It's a dog eat dog world, as they say. This can hit revenues.

AT&T reports a Q1 revenue "miss"

Overall, our revenue expectations for AT&T Inc.'s Q4 2022 were slightly more conservative relative to consensus. Analysts covering the company were targeting a consensus of $30.24 billion. We expected revenue to right at $30.2 billion, with minimal year-over-year growth. With $30.14 billion in revenues, this was a "miss" of $80 million vs consensus, and $40 million versus our estimates. In effect, however, it was in line.

AT&T Q1 revenue drivers

Wireless postpaid growth saw 0.542 million adds, and these continue to be boosted by 5G availability as well as promotions put into place during the quarter. AT&T also reported 0.272 million fiber net adds, which surpassed our estimate of 0.215 million fiber net adds. Both of these results are strong, and postpaid adds continue to be industry leading. The fiber add result now marks the 13th straight quarter of 0.2 million adds or more. For 5G, they are now covering over 160 million people. That is quite impressive and well above the pace management expected just a year ago. Domestic wireless service revenues were up 5.2%, and they had strong mobility operational performance. Consumer broadband revenues were up 7.3%. Overall, the results were "ok."

AT&T Q1 bottom line earnings

So, the roughly in-line top line performance, which grew 1.4%, helped drive the bottom line to a beat versus consensus in conjunction with cost savings measures. This is perhaps the most bullish point of the quarter. The company is now on pace to see $6 billion in run rate cost savings before the end of the year 2023. That is strong. It can help preserve earnings.

That said, analysts were looking for $0.59, and this was surpassed by $0.01. Our target range was $0.56-$0.60, so this was at the higher end. Expenses still remain a bit higher than we would like, but the cost savings efforts are notable. Operating expenses were $24.1 billion, about flat from a year ago. Operating income grew from last year to $6.0 billion, up $500 million.

Remember, we like AT&T as a dividend play. When we suggest selling, it is not because the sky is falling. We do believe the market is headed lower. But we also teach our members how to trade around a core position and increase their overall returns. This is on top of call selling against long positions that pay a dividend.

That said, we simply wanted you to be able to get a better price, and that opportunity arose. $1.00-$1.50 per share may not seem like much, but it is about 6-9 months of dividends. For the dividend it is all about cash flow. Free cash flow is critical

AT&T Q1 free cash flow fails to cover dividend

Free cash flow is critical to covering the dividend payment. We targeted Q1 free cash flow would be $2.5 billion. Free cash flow was just $1.0 billion. We were off on our expectations, as cash from operating activities was $6.7 billion, and capex was $4.3 billion, while cash for vendor financing was a wildcard and was $2.1 billion. With dividends paid of $2.01 billion, after dividends, the free cash flow is negative $1 billion. Overall the payout ratio was 200%. However for the year, the payout ratio is still projected to be in the 60% range, as Q1 is generally a weaker quarter for free cash flow.

AT&T's debt

The AT&T Inc. debt remains a huge risk. Did you know that, despite the efforts to reduce debt, that debt increased sequentially? Ouch. Keep in mind with interest rates rising so much that debt refinancing or new debt taken on will be at much higher rates and increase interest expense. However, there is a long time until most maturities, so it is not an immediate concern. The company uses debt to grow. Management had been improving the balance sheet by selling off assets and paying down its debt. The net debt was $132.2 billion to start Q1 and they ended with $137.5 billion of total debt, with net debt of $134.7 billion considering cash. The net debt-to-adjusted EBITDA of 3.2X. That said, the company believes in the next two years it will chip this ratio down to 2.5x.

Final thoughts on AT&T Q1 and the outlook

This AT&T Inc. report was mixed. The outlook remains a bit cloudy, but we think it was wise to take some off the table around $20 per share. The debt took a minor bump higher, but it continues to be addressed. The dividend was not even close to being covered, but for the year, it will be covered. As we look ahead to 2023, we see revenue growing 3%-4% on better pricing and more customer adds. We see earnings coming in around $2.40-$2.55 for the year. That puts shares at about 8X FWD EPS, which is pretty attractive, but we still think you will be able to get shares for $17 again.

Overall, we stand by our recent call to sell AT&T Inc. stock at $20 and to consider repurchasing lower. We think you get that chance on these results as well as a broader market selloff.

Your opinion matters

Is waiting for AT&T Inc. at $17 too conservative? Do you like the name for income? Do you think it is foolish to sell around the core position? Have a better name for income to recommend? Let the community know below.

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