TBC - Zero Reason To Own AT&T

2023-08-24 18:06:06 ET

Summary

• Investors are divided on the prospects for AT&T stock, with concerns about debt and competition, while income-thirsty investors see a secure payout.
• Some see the dividend at risk, but there is no support for such an assertion in the immediate term.
• Subscriber adds continue to largely impress, while the market is seriously underappreciating cost reduction efforts.

Make no mistake, investors are divided on the prospects for AT&T ( T ) stock. Some believe that the stock is undervalued and is a good investment for income, while others are concerned about the company's debt burden and free cash flow generation being at risk, on top of all the competition out there. We were long time owners, then became bearish and shorted the stock, only to return to the stock when it hit the mid-teens. We believe the stock has found its bottom in the $13-$14 range. It amazes us to hear from readers, time and again, that "There is zero reason to own AT&T." We seek to address this assertion.

We believe that the biggest issue here is that our followers who think there is no reason to own AT&T here believe the dividend is at risk again, on top of the stock being unlikely to rebound. We are throwing cold water on the dividend possibility, while a rebound will come as investors see the name as viable for income. Just today, we were asked in our investing group "should I dump AT&T, the dividend looks like it is at risk." But we do not understand the dividend being called into question. In order for the dividend to truly be at risk, free cash flow would need to be falling off a cliff, and not covering the dividend. Simply put, the performance and forward expectations simply do not support this assertion. We are big believers in the stock rebounding, and have been buying. The more you sell, the more we thank you, as we love the cheap shares to collect the bountiful near 8% yield. We are also employing a covered call strategy along with a cash secured put selling strategy to ramp income on the ticker.

So why then do we assert the dividend is not at risk. Folks, it may seem simplistic, but it is evidenced by the company's recently reported Q2 earnings . Admittedly, those results were mixed, but were much stronger than the Q1 report which really sparked the last massive wave of selling.

What do we mean? Revenue was down slightly, but earnings per share beat expectations. Overall, our revenue expectations for AT&T Inc.'s Q2 2023 were met. The many Street analysts following the company were targeting a consensus of $29.95 billion for that second quarter. Revenue of $29.92 billion was about as expected.

One area of low-hanging fruit for both bulls and bears is to dissect revenue drivers. We are taking account adds essentially. Bears point to slowing numbers, and lower revenue per user. Bulls point to ongoing growth overall. There is merit to both, but one has to question when are both cases priced in? Based on the numbers, we opine that the negatives are fully priced in. For AT&T in Q2, wireless postpaid growth was a net 0.464 million adds. The wireless postpaid adds are still seeing a benefit of 5G availability as well as promotions put into place during the quarter. Of course, those promotions can, over time, reduce revenue per customer, which lends some evidence to the bears. The promotional nature is of course sector wide in the telecom space. Fiber is also enjoying gains. AT&T 0.272 million fiber net adds in Q2, above our estimate of 0.251 million fiber net adds. We will remind you that this was the 14th straight quarter of 0.2 million adds or more. Looking ahead, we project a 15th straight quarter of this level of adds. Now, in terms of revenue, volumes helped push most consumer wireless service revenues up 2.4% from last year. Business wireline revenues, went the other way, falling down 5.6%. Overall, the results were mixed, so, you can interpret the results both bullishly and bearishly. However, we err on the side of bullish as in the $13-$14 range, we see the negatives priced in at these levels. Keep in mind, top line revenue was still up 0.9%.

The revenue growth and well-controlled expenses also led to a beat versus consensus. The bears in our opinion are discounting the fact that AT&T is set for a $6 billion in run-rate cost savings before the end of the year. The cost savings are really having an impact and the Street thus far has not appreciated them in our opinion. Operating expenses were actually just $23.5 billion, down 4.8% from a year ago, and down 2% from the sequential quarter. As such, operating income grew from last year to $6.4 billion, up $1.4 billion from a year ago, and up $400 million from the sequential quarter. This is a solid result. Analysts were looking for $0.60 in EPS, and this was surpassed by $0.03 with the $0.63 in EPS.

Now, the dividend. It makes zero sense right now to be questioning the safety. The only way we could see them slicing the dividend is if they say, "we are going to prioritize cash flow to debt." It simply is not going to happen. For a few years, management has been improving the balance sheet, as it has sold off assets and paid down its debt. Over $20 billion in debt has been reduced in the last few years. The net debt was $134.2 billion to start Q2, and they ended with $132.0 billion of net debt, considering cash. And here is the thing folks, the net debt-to-adjusted EBITDA was 3.2X, which is high. But management anticipates in the next two years it will reduce this ratio down to 2.5x. At no point has management said or even hinted they need to cut the dividend to do this. For the dividend, it is all about cash flow. Folks, watch the free cash flow. We would argue the stock to a degree trades with cash flow. When free cash flow was horrific in Q1, the stock tanked. The stock stabilized over the last month, largely, because free cash flow was $4.2 billion with cash from operating activities was $9.9 billion. With dividends paid of $2.01 billion, the payout ratio was less than 50%. In no way is this a dividend at risk. But moving forward, is the payout ratio projected to rise to unsafe levels? No, it is not. 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.

We simply do not think questioning the dividend right now makes any sense. We could change our mind in two years if data meaningfully deteriorates from here. If free cash flow projections and results show ongoing declines, we might join the bears again, but we do not see it. In fact, we think the downtrend has come to an end as the debt burden continues to be addressed. There is zero denying the fact the dividend was easily covered by strong cash flow and for the year will easily be covered. With a stock at these levels, buying support from income thirsty investors should support share prices. And, our forward view is pretty positive, all things considered. As we look ahead to the rest of 2023, we are resolute in our forecast for revenue growing 3%-4% on better pricing and more customer adds/volumes. We further see EPS in the range of $2.40-$2.55 for the year. That is less than 6X FWD EPS, which is incredibly attractive. Buy the stock for the dividend, and hold it for capital appreciation potential.

Your opinion matters

Do you like the name for income? Do you see cash flow cratering? Sure, it has done nothing, and may do nothing, but is that so bad for an income stock from these levels? Have a better name for income to recommend? Do you see the stock at its bottom? Let the community know below. Looking for direct guidance to ramp up returns? Check out the popular group below.

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