2013 has not been a good year for AT&T (T). The company has had only limited success reversing serious revenue declines in several of its legacy segments. In addition, AT&T may be considering overseas acquisitions to offset declining revenues. However, even with these negative factors, AT&T has still managed to return large amounts of capital to its shareholders via dividends and stock buybacks. AT&T currently offers a $0.45 per share quarterly dividend and yields about 5.35%.
Q2 2013 Overview
The best that could be said about AT&T's Q2 2013 was that it was better than its prior quarter. The company saw continued weakness in its legacy wireline voice segment and moderate growth in its wireless segment.
For the quarter, AT&T posted revenues of about $32.1B, up 1.6% from last year and up 2.3% from last quarter. Net income came in at $3.8B, or $0.71 per share, compared with $3.9Bm or $0.66 per share last year. Do note that net income was positively impacted by the sale of AT&T's stake in América Móvil (AMX) to the tune of $0.04 per share.
A closer look at AT&T's revenues
AT&T's wireline revenues came in at $14.8B, down 1% from last year and up less than 1% from last quarter. The vast majority of the decline in wireline revenues came from the above mentioned voice segment, which saw revenues collapse to $5.1B, a sharp decline of 11% from last year and a 4% decline from last quarter. Wireless revenues came in at $17.3B, up 5.7% from last year and 3.5% from last quarter. The vast majority of wireless revenue gains came from increased data revenues, which grew to $5.4B, up 20% from last year and up 4% from last quarter.
Cash generation remains strong for AT&T
Probably the most important metric other than revenues for AT&T is its free cash flow, or FCF. For the quarter, AT&T generated about $9.5B in operating cash flow, spent $5.5B in capex, and was left with about $4.0B in FCF. It should be noted that AT&T generated about $100M more in FCF in Q2 2012 than in Q1 even with over $1B more in capex. This was largely a result of stronger operating cash flow and higher depreciation expenses.
Free cash flow easily covers dividend payments
For most investors, AT&T's most compelling aspect is its outsized dividend yield. Using EPS, AT&T's TTM payout ratio appears to be a dangerously high 130%. However, a much better method to determine the safety of AT&T's dividend is by looking at its FCF payout ratio. Since 2008, AT&T's dividend has generally ranged from 40% to 60% of its FCF and has been trending lower as its capital spending needs wane. Except for Q4 2011, AT&T's FCF per share has exceed its dividend per share every quarter over the past 5 years.
Stock buybacks may slow down as debt rises
Since about Q1 2012, AT&T has been very aggressively buying back stock, reducing its total shares outstanding by about 10%. However, AT&T has been funding these share buybacks mostly with debt. The company bought back around 89M shares for $3.3B in the second quarter and has about 272M shares remaining on its current buyback program. However, AT&T hinted in its Q2 2013 conference call that it may scale back on its share buybacks as it does want to take on more debt or increase its leverage. AT&T noted in the conference call that it aims to keep its net debt to EBITDA ratio at around the 1.8X range. AT&T's net debt to EBITDA load as of quarter end was about 1.67X, and is expected to increase as a result of its $4B purchase of Leap Wireless (LEAP).
AT&T's performance has lagged behind rival Verizon
AT&T is down about 14% from its 2013 high of $39.00 reached in April. YTD, the stock is about flat, not including reinvested dividends. At current prices, AT&T seems to be undervalued, especially when compared to its main rival Verizon (VZ). Up until mid-April, AT&T's stock was actually performing similar to Verizon's.
This is odd especially considering AT&T offers both a higher dividend yield (5.35% vs 4.40%) and more generous stock buybacks than Verizon. Do note that both stocks have lagged the broader market which may point more towards some sector related weakness than anything company specific.
AT&T's weakness in 2013 somewhat perplexes me. While the company is experiencing rapid declines in its legacy wireline voice revenues, it is seeing growth in the more important wireless segment. In addition, AT&T has continued to generate strong FCF, which has allowed it to pay large dividends. FCF generation will be the key metric in which to judge AT&T's future dividends and share buybacks, which seem to be the main method AT&T's shareholders have to see returns.
At current prices, AT&T seems to be a better buy than rival Verizon. Frankly, both stocks look like buys at current prices. Do note that I think part of the reason for the underperformance in this sector lies with the broader sell off of anything with a high yield. AT&T is unfortunately a victim of this trend as more investors move away from the safer "blue-chip" stocks and more towards growth-oriented names.
Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.