AT&T - Competition, Leverage And Cash Flow Pressure Limit Appeal

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 |  About: AT&T Inc. (T), Includes: TMUS, VZ
by: The Value Investor

Investors in AT&T (NYSE:T) are not happy with the guidance for this year's cash flows. Lower operating cash flows, combined with continued growth of capital expenditure requirements puts available cash flows to return to shareholders under pressure. This is unless AT&T again increases its already large debt position.

Given the leverage employed, intensified competition and lower operating cash flows, I remain very cautious despite the attractive 5.5% dividend yield.

Fourth Quarter Headlines

AT&T reported fourth quarter revenues of $33.16 billion, up by 1.8% on the year before, and ahead of consensus estimates at $33.06 billion. The company reported GAAP earnings of $1.31 per share versus a loss of $0.68 per share a year before.

Note that GAAP earnings are very volatile and non-GAAP adjusted earnings of $0.53 per share give a better picture about AT&T's performance. These earnings rose by a fifth compared to last year, and beat consensus estimates at $0.51 per share.

Looking At The Numbers

AT&T's GAAP numbers were a mess, so I took a look at the non-GAAP results to get a better idea about the company's performance. Despite the modest top line growth, AT&T cut operating expenses by $400 million to $28.0 billion.

As such, operating margins advanced by 260 basis points to 15.5% of total revenues, with operating earnings totaling $5.2 billion. Adjusted net earnings of $0.53 per share imply that earnings were $2.8 billion.

Wireless revenues rose by 4.5% to $18.44 billion, with growth continued to be driven by data revenues, which rose by 16.8% to $5.73 billion. Voice, text and other revenues fell by 1.1% to $9.93 billion as equipment sales rose by 3.1% to $2.78 billion. The company announced the lowest churn rates ever at 1.11%.

The wireline business reported a 1.4% decline in sales to $14.72 billion. Again, data continues to drive growth with revenues being up by 5.6% to $8.57 billion, while voice revenue declines accelerated to 11.0%, as sales fell back to $4.86 billion. AT&T reported 630,000 high speed internet additions and 194,000 u-verse TV subscriber additions.

2013 In Review

For the full year, AT&T reported revenues of $128.75 billion, which is up by 1.0% on the year before. Note that adjusted for the divestment of the advertising solutions business, revenues would have been up by 1.9% for the year.

Reported earnings came in at $18.2 billion, aided to a large degree by actuarial gains on defined benefit pension plans. Adjusted for this, earnings came in at $2.50 per share, or little above $13 billion.

Operating cash flows fell to $34.8 billion after posting record results in 2012. Lower cash flows are the result of the timing of cash tax payments, among others. At the same time, Project VIP boosted capital expenditures to $21.2 billion for the past year, putting pressure on free cash flows.

All About The Network

CEO Randall Stephenson confirmed that the past year has been all about the network. Project VIP allows greater speeds and new services for millions of customers. The company's 4G LTE network is nearing completion and is the most reliable network in the nation according to the company itself.

AT&T covers nearly 280 million POPs at the moment with competition of the LTE network anticipated this summer.

Looking Ahead

The outlook is a bit soft. Revenues are seen up by 2 to 3% for this year, driven by strength in wireless services and wireline consumer revenues. Wireless margin expansion should offset margin pressure in wireline Project VIP investments. Analysts were looking for revenue growth of 2% for this year.

Adjusted earnings per share for 2014 are seen up in their mid-single digits, not factoring in the beneficial impact of share repurchases. Analysts were looking for earnings growth of 7% for the year.

Free cash flow is expected to fall further to $11 billion after projecting capital expenditures of $21 billion. This outlook suggests that operational cash flows are expected to fall to $32 billion, down from $34.8 billion last year.

Pressure On The Balance Sheet...

Operating cash flows minus capital expenditures for the past year totaled $13.6 billion. Yet AT&T spends much more per annum in order to please its investors. Over the past year alone, AT&T spent $13.0 billion to repurchase 6% of its shares outstanding. Yet the quarterly dividend payments of $0.46 per share, costs the company close to another $10 billion per annum.

These cash outflows continue to put pressure on the balance sheet. While the company holds a comfortable $3.3 billion in cash and equivalents, its net debt position came in at $71.5 billion. Note that AT&T has another $30 billion in post-employment obligations on its balance sheet.

While AT&T remains committed to its dividend, and expects to make "opportunistic" share repurchases in 2014, after cutting the pace of repurchases to just $1.9 billion in the fourth quarter of last year.

...While Competition Heats Up

AT&T is facing increasingly more competition, notably from T-Mobile US (NASDAQ:TMUS). In that light, net wireless additions of 566,000 for the final quarter are light. These gains fell short to consensus estimates at 575,000 and customer gains of 780,000 last year.

In comparison, T-Mobile gained 869,000 subscribers in the final quarter, while Verizon Communications (NYSE:VZ) gained 1.6 million new contract users.

Notably T-Mobile stepped up getting rid of long-term practices like signing up customers to long-term contracts, and offering credits to switch service.

Takeaway For Investors

The increased price pressure, high capital expenditures requirements, large debt position and high payouts to investors limit the maneuvering room for management. Ironically enough, AT&T tried to acquire T-Mobile USA a few years ago for $39 billion and this cost the company a lot in break-up fees and increased competition at the moment. The signs of stagnation and competition are heating up the debate about a possible interest in Vodafone.

AT&T already cut back the pace of share repurchases to $7.6 billion per annum in the final quarter, yet operational cash flows do not leave much, if any room for repurchases this year. If AT&T would continue to repurchase shares at its current pace, the company would further add to its debt position.

I foresaw such a scenario back in October of last year, concluding that AT&T is trying to please its investors too much.

Worries about competition and increased leverage limited the performance of AT&T, which has been trading flat over the past year. Note that shares did see a peak around $39 in April of last year, after which shares saw a roughly 15% sell-off.

If wireless revenue growth is stalling due to lower net additions, AT&T might be suffering dearly given the continued declines in the wireline activities.

I reiterate my standing. The dividend at over 5.5% per annum is very attractive, yet it does not seem too sustainable at the moment. The leverage and opportunistic M&A activity are red flags. I would be more comforted if AT&T remains committed to not engage in M&A activity while cutting back the pace of share repurchases to contain the debt position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.