Home Front end AT&T tumbles after free cash flow shortfall: The hidden risk (NYSE:T)

AT&T tumbles after free cash flow shortfall: The hidden risk (NYSE:T)


justin sullivan

After directing its spin-off from Warner Bros. to create the new Warner Bros. stock. Discovery (WBD), AT&T (NYSE:T) finds himself again on his own. The stock fell after the release of second quarter results, largely due to a reduction in its free cash flow forecast. A cut in dividends hasn’t helped either, although the stock is still yielding 6%. The stock trades for just over 9x free cash flow, but any money after the dividend will likely go to paying down debt for many years. In light of the expected lag in cash returns, the stock is actually not trading as cheaply as it looks.

Stock price T

T had a tough year even though it’s not a tech title.

T stock price chart
T data by YCharts

I last wrote about T in March, where I explained why I considered the stock to be sellable before the WBD spin-off. The stock has generated total returns of 4% since then, but I still view the stock as devoid of compelling reasons to buy, even today.

Key AT&T Stock Metrics

T’s latest quarter saw surprising subscriber strength, though that didn’t necessarily lead to bottom line strength, as adjusted EPS barely rose to $0.65 per share.

AT&T Revenue, EPS and Operating Cash

Slides Q2 2022

T added 813 postpaid subscribers and 316 fiber subscribers during the quarter.

AT&T Subscriber Earnings

Slides Q2 2022

T was also able to increase the average revenue per mobility user by 1.1% to $54.81.

Mobility AT&T 2Q22

Slides Q2 2022

In general, T has been able to maintain stronger ARPU growth in its broadband division (which makes sense, I’m sure many readers can relate to the constant increases in internet prices).

AT&T Consumer & Business Wireline Results

Slides Q2 2022

T left his outlook virtually unchanged, although he cut his free cash flow forecast from $16 billion to $14 billion.

AT&T Outlook 2022

Slides Q2 2022

This shortfall was explained as being mainly due to the increased timing of collections from consumers. There still remains the question of how T expects to honor even the reduced advice. While T has only generated $4.2 billion in free cash flow so far, it expects to hit $14 billion by the end of the year due to the fact that it loaded its capital investment, which led to a decline in capital investment in the second half. of the year.

T continues to expect $24 billion in capital investment this year as well as $24 billion in capital spending in 2023. What drove the stock down?

I suspect it was due to comments on the conference call implying that it may not be able to achieve the previously guided $20 billion free cash flow next year, although they reiterated at previous quarter. Sure, inflation and macro headwinds are taking their toll on the market, but I doubt many T investors were expecting this disappointment just months after the previous quarter.

T ended the quarter with debt of $131.9 billion, or a debt-to-adjusted EBITDA ratio of 3.2x. Management has indicated that its priority is to reduce debt to 2.5 times debt to EBITDA. The annual dividend of $1.11 per share is expected to consume about $7.9 billion in cash flow per year. Based on an annual free cash flow of $16-20 billion, T might need 5 years to resize its balance sheet.

Is stock T a buy, sell or hold?

Following the WarnerMedia split, it cut its annualized dividend to $1.11 per share. This puts the stock at a dividend yield of 6%. I suspect many investors are looking to ample free cash flow instead – T is trading at an 11% free cash flow yield. A bullish investment thesis might be: collect a well-hedged 6% dividend yield while waiting for the company to repay its debt. Once the company aligns its leverage with its 2.5x target, it can aggressively increase its dividend or buy back shares. The stock would potentially offer multiple expansion much sooner in anticipation of increased returns for shareholders.

While I can respect the simplicity of this thesis, I remain skeptical. Based on the many acquisitions over the past decade (DirecTV and Time Warner stand out), it’s clear that T’s management team might have issues with “simple capital allocation.” As a former shareholder of T myself, I remember that management had made promises before about reducing leverage. T originally thought he could reduce leverage to 2.5x debt to EBITDA by 2018, but leverage is 3.2x debt to EBITDA. ‘EBITDA 4 years later, even after waiving much of its debt to WBD. This is a case where management background gets in the way of what should be a clear thesis. Additionally, I wonder if the rise of 5G will negatively impact the broadband business, leading to some cannibalism in this line of business. The broadband business has historically helped offset slow growth in mobility to accelerate overall growth rates – this is a tail risk that makes the 11% return on free cash flow quite justified. Nonetheless, the stock is by no means expensive with an immediate dividend yield of 6% and potential for increased returns for shareholders several years from now. Perhaps it’s a name investors should keep an eye on, to see if debt-to-EBITDA ratios continue to fall and only buy later as the prospects of aggressive share buybacks emerge. . For now, I am rating the stock as a buy as the valuation is unconvincing in the current environment (I continue to favor growth stocks after the tech crash) and there are few catalysts to justify a multiple expansion.