AT&T: Short-Term Fall Is Due To Long-Term Problems

Source: Investing.com

The problem with that argument, however, is that it requires viewing the Q2 report in a vacuum, rather than in the context of AT&T’s tortuous history over the past two decades. The issue with the AT&T earnings report is that it served as a reminder of precisely that history — and why it’s so dangerous to bet that this time is different.

The news last Thursday doesn’t seem like it would shake the confidence of an investor who believed in the stock on Wednesday. The case for T stock before earnings was that the end of a disastrous foray into entertainment would allow the newly slimmer company to better compete with wireless rivals. That, in turn, would drive cash flow growth that would allow the stock to re-rate higher, and the company to increase an already generous dividend that at Wednesday’s closing price yielded 5.4%

That case seems potentially supported by Q2 earnings. Most notably, AT&T does seem to be competing better.

The company added 813,000 net postpaid phone subscribers in the quarter and more than 1 million net postpaid subscribers in total. Verizon Communications (NYSE:VZ) on Friday announced that it added just 12,000 net postpaid phone subscribers.

Admittedly, AT&T reduced its guidance for free cash flow this year, to $14 billion from $16 billion. Headlines suggest it was that lower guidance that led to the sell-off. But, as management explained on the Q2 conference call, some of the pressure on cash flow is coming precisely from the company’s success in acquiring new customers.

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Those new customers receive new devices, which in turn erodes short-term cash flow. But obviously from a long-term perspective, those new customers can boost growth.

To be sure, there were other negatives in the quarter. Management said inflation had led its cost estimate for the year to rise by more than $1 billion. AT&T also cited slower-than-expected collections on postpaid accounts, though executives clarified on the call that delinquencies were only modestly above 2019 levels.

Those negatives seem to be relatively short-term problems. An AT&T bull would argue that those short-term problems are less important than the long-term benefit of subscriber growth. From this perspective, the sell-off on Thursday is an overreaction, driven by a failure to fully understand the lowered free cash flow guidance.

And the decline last Friday makes even less sense; VZ stock fell nearly 7% after a bad quarter, but that quarter only highlighted how well AT&T performed during Q2.

Again, I’m not unsympathetic to that argument. But a closer look at the quarter highlights a number of long-running concerns that have led T stock to be a long-term underperformer. (Over the last decade, AT&T stock, including dividends, has returned less than 4% annually.)

The first problem, as an analyst noted after the report, is that AT&T management has no credibility left .

This is a company that, as I noted earlier this year, jump-started the growth of rival T-Mobile (NASDAQ:TMUS) by trying, and failing, to make an acquisition that had essentially zero chance of receiving anti-trust approval. It bought DIRECTV when it was already obvious that streaming services were on the rise, and satellite TV was a declining business. It doubled down on that mistake by badly overpaying for Time Warner, which finally was spun off earlier this year.

The chief executive officer who led those acquisitions, Randall Stephenson, is gone. But the current CEO, John Stankey, was intimately involved in all of those deals. So were most of the current AT&T board of directors. So, when AT&T tells investors that a guidance cut is due to temporary factors, investors simply don’t believe the company. It’s going to take quite a bit of time for that to change — if it does at all.

The second problem is that AT&T, even with better subscriber figures, isn’t growing much. Adjusted earnings per share (excluding Time Warner results in the year-prior period) increased by one penny year-over-year. Comparative EBITDA (earnings before interest, taxes, depreciation, and amortization) rose 1.7%.

That’s minimal growth in a hot economy, where flush consumers are buying newer phones, getting better service, and adding new lines for tablets. So, what happens when the economy inevitably turns? And is the stock cheap, at roughly 9x this year’s free cash flow guidance, if that cash flow has the potential to decline?

The risk to cash flow was highlighted by a final issue is one that all too often has been ignored for years now, as income investors fixate on the dividend yield. AT&T still has a substantial presence in wireline service. And the business is declining quickly. For the Business Wireline, results disappointed. Revenue fell 8%, and profit 15%; management admitted on the conference call that the declines were larger than expected.

Business Wireline still is a big business, accounting for more than 20% of AT&T EBITDA in 2021 (using figures that exclude WarnerMedia). Accelerated declines there — and secular trends are ending the use of landlines in businesses across the country — can offset growth from wireless and from fiber.

Again, a two-session 10% decline probably is a bit too much in the context of what looks like mixed results. And it’s possible that AT&T finally gets its turnaround to work and finally drives the growth and share price appreciation for which investors have been waiting for years.

But the concerns here are real. AT&T stock doesn’t yield 6% because the market isn’t paying attention. It’s not valued at 9x this year’s free cash flow because investors don’t understand the business.

The opposite is true. AT&T stock looks cheap because investors, overall, don’t believe the company is going to grow cash flow.

In that context, the negative reaction makes some sense. A management team that’s lost investor confidence cut free cash flow guidance for this year by 12.5% and refused to clearly reiterate its previously announced expectation for 2023. Business wireline erosion and delinquent accounts add the potential for further pressure going forward.

Those concerns existed before Thursday, and those concerns were emphasized by the Q2 report. Until AT&T management can completely assuage those concerns and re-inspire investor confidence, AT&T stock isn’t going anywhere.

As of this writing, Vince Martin has no positions in any securities mentioned.