AT&T: Here's The Issue

| About: AT&T Inc. (T)

Summary

The company has morphed into the new AT&T but can it perform?

Q2 earnings are out and I discuss the key metrics.

What to look for going forward.

I have told you that I keep 20-25% of my portfolio in high yield, which I define as anything over 4%. This has led to a solid stream of income as well as dividend reinvestments that will compound and build wealth for future income. Now, I own just one telecom, but it has consistent dividends that are reliable and are raised year after year. I'm talking about AT&T (NYSE:T), which I have discussed in many articles. Overall, the share price had been very stable, it was reliable for income, but now growth has kicked in and shares have spiked in 2016. I like that. Although the growth is nice I depicted the incredible strength of the company's growing dividend payments over time, and it really is impressive, and that is why I own the name. But as time has moved forward, the company has morphed into the new AT&T

Here is the issue. In order to support the share price growth we have seen (that is, to maintain it), we have to look at the performance of the company. The problem is, we do not know if performance truly supports the move in share prices. While I have focused on the innovation of the company, the strength of the dividend and its debt, I haven't reviewed performance numbers since the spring. Coming into 2016, AT&T has had a history of so-so quarters, but the quarters have also rarely been poor or rarely been astounding. But with a string of recent strong moves for the future, a growing wireless network bringing in new customers with its strong LTE signal and a 4G LTE network, and its TV/high-speed Internet service deals, investors have higher expectations than, say, a year ago. So, our major

In its just-reported Q2, AT&T delivered performance that met my expectations, but didn't beat estimates like I really wanted to see and I fear this may negatively impact the quarter. It was strong. First, the revenues. These actually missed analyst estimates slightly. They came in at $40.5 billion. But it's just a headline number and doesn't tell us much, so we have to dig deeper. It's notable that these revenues are up 22.7% year over year. That's incredible for a telecom giant of this size, but is in large part due to the DIRECTV acquisition.

Of course, with such a giant purchase, we have to be on the lookout for expenses rising at a rapid clip weighing on margins. Well, compared with Q2 2015, operating expenses were $34 billion versus $27.2 billion. This year-over-year rise does not surprise me considering all of the new assets under management. Sequentially, expenses were up $600 million. That said, I am very pleased that operating income rose to $6.6 billion versus $5.8 billion last year. But if we adjust for merger expenses, operating income was $8.1 billion versus $6.5 billion, while operating income margin was 20.1% versus 17.1% last year. Further, operating income margin was up from the 17.9%, from Q1 2015. That's a big win.

Taking into account revenues and expenses, net income was $3.4 billion, or $0.55 per share, compared to $3.1 billion, or $0.59 per diluted share in the year-ago quarter. But it's a GAAP number and doesn't tell us much. Thus, an adjusted number is more appropriate. If we adjust for $0.17 of costs primarily for merger and integration-related items earnings per share was $0.72 compared to an adjusted $0.70 in the year-ago quarter, an increase of 0.3%. This was in line with analyst estimates. There was strong cash flow of $10.3 billion in operational cash, up 12.5% and $4.8 billion in free cash flow after capital expenditures, up 8.4%.

AT&T did not alter its guidance. But at least check the company sees double-digit revenue growth, with adjusted earnings growing in the mid- to high-single digits. It expects stable margins, capital spending of about $22 million and a 70% payout ratio for the dividend. Recall, the dividend is up another penny from last year. I am looking for another penny raise again this year as the debt gets paid down. While the headline numbers weren't that impressive, the fact is this is generally a slow quarter. Many new releases of hardware come out in late Q3 and Q4, so look for new customer additions at this time. Despite the so-so nature of this quarter, AT&T continues to be a serial dividend raiser, and it is my hope to see a $0.50 quarterly dividend by the end of 2017.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I am/we are long T.

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.