- AT&T started the year better than expected.
- HBO Max is riding the momentum and the reopening of theaters helped the WarnerMedia segment to return to growth.
- AT&T remains a truly cash-flow resilient company and its almost 7% dividend remains secure as the company's capital allocation strategy focuses on deleveraging.
- The stock has a lot of potential at this stage and investors shouldn't miss to lock in an almost 7% dividend yield.
AT&T (NYSE:T) finally managed to break the $30 barrier in late 2020 and overall euphoric stock market sentiment provided some good support for the stock prior to its Q1/2021 earnings print.
Significantly better than expected earnings both on the top and bottom lines have provided further support to AT&T's stock price and there is strong potential for a lasting run of the stock.
While AT&T had still not raised its dividend for 6 consecutive quarters the current yield of 6.6% leaves no real reason for complaint. Management has ducked away from focusing on debt repayment and dividend growth and instead has put debt repayment as the clear no. 1 priority for using excess cash flow while at the same time remaining committed to keeping the dividend stable.
For me this is good enough for now as the very expensive C-band spectrum which added almost $20B in additional debt to AT&T's balance sheet makes a solid case for using excess cash flow in prudent fashion.
AT&T has been a "show me" story ever since the company announced the Time Warner acquisition back in late 2016. Now more than 4 years later with HBO Max in the market, it appears that AT&T is finally showing that it can deliver and that its vertical integration strategy is reaping rewards.
What is going on at AT&T?
AT&T's first quarter 2021 earnings release was an all-out success featuring a comfortable double beat and the best revenue growth figures since its Q3/2016 report. Sales climbed 2.7% Y/Y to $43.9B and EPS reached $0.86 which is $0.02 higher compared to the prior year.
AT&T started strongly into 2021 driven primarily by growth in its Mobility segment and renewed strength in Warner Media now that AT&T is lapping the COVID-19 sensitive quarters of 2020. AT&T's largest segment Mobility grew revenues by a surprisingly strong 9.4% Y/Y driven by over 3.6M U.S. Wireless net adds, low churn and very strong phone ARPU of $54.10. Postpaid phone net additions came in at 595K which is substantially stronger than the 163K net additions in the prior year. Strong top-line growth of the segment weakened on its way through the profit and loss statement as adjusted EBITDA only grew by 2.3% as wireless service margins contracted by 100bps due to aggressive discounts on 5G devices.
Growing customer relationships is one of AT&T's primary objectives and similar to a strong showing in wireless we can also observe strong performance in Fiber (235K net adds which is slightly up on the 209K net adds in the prior year quarter) and HBO Max where the customer base of HBO Max and HBO subscribers grew by almost 3M sequentially.
AT&T's WarnerMedia segment grew sales from $7.8B to $8.5B, an improvement of almost 10% driven by strong momentum in HBO Max and improved advertising trends as sports has returned. While cinemas have only gradually started to pick up business in the first quarter WarnerMedia has been releasing all its cinema releases for HBO Max which is driving subscription growth and helps generate insights into how such a dual strategy of releasing new content for both cinemas and HBO Max could work.
Focus on HBO Max
Ever since AT&T launched its HBO Max streaming service a year ago, the narrative has more or less completely shifted to AT&T's streaming results and away from the staggering erosion of its video subscriber customer base.
HBO Max has seen domestic subscribers reaching 44.2M this quarter, up from Q4's 41.5M with worldwide subscribers of 63.9M. While this is still far away from Netflix's (NFLX) over 200M global subscribers and Disney+ (DIS) with its over 100M subscribers, it is much better than what AT&T had expected when it unveiled HBO Max plans to investors. Back then AT&T expected to close 2020 with 36M domestic HBO subscribers which is a far cry away from the 41.5M it actually had. The 7-year plan was projecting domestic HBO subscribers only to reach 44M by the end of 2023, which essentially means that AT&T is currently ahead almost 2 years vs. the original plan.
Source: Warner Media Day - HBO Max Presentation
That's why AT&T recently significantly raised its long-term projections for HBO subscribers and is currently forecasting between 120M and 150M global HBO Max/HBO subscribers by 2025, with AT&T set to launch into 60 international markets this year and its red-hot ad-supported video on demand (AVOD) HBO Max offering slated to come this quarter.
AVOD is supposed to be great for consumers as they can get HBO Max at a substantially lower price and also good for marketers as they can reach the more price-sensitive audiences. According to leaked information on CNBC this ad-supported version of HBO Max is rumored to cost $9.99 which would be substantially cheaper than standard HBO Max at $14.99 a month as well as cheaper than Netflix's standard plan at $13.99 a month.
HBO Max has turned out to be a success so far for AT&T and one reason for that is presumable also - the pandemic-enforced decision from WarnerMedia to release all of its 2021 film slate on HBO Max the same day as the film hits cinemas. This is very aggressive but so far seems to have paid off with Godzilla vs Kong having been a box-office hit and a catalyst for HBO Max subscriber growth. One month into its release Godzilla vs. Kong has earned $406M worldwide which is roughly twice its $200M budget.
AT&T's management is very satisfied with what it has seen so far:
What we've seen is not only good viewership of those movies on HBO Max but engagement that's been encouraging, so real success with it so far
I fully endorse that decision by management because when that decision was made more or less the entire 2020 film year had been abandoned. With so many blockbuster movies delayed or postponed it could have led to a situation where all the studios are rushing to bring their films to theaters once these are allowed to reopen. This would incalculably change the economics of these box office releases anyway and thus it was an aggressive bet to take but one which surely paid off. The simultaneous release in theaters and streaming has been like a "rising tide lifting all boats".
This also makes sense intuitively in my view given that the traditional cinema experience has always been very distinct from the home cinema experience and thus the target audience is certainly not fully overlapping. In fact, it is very likely that those people who do not want to pay the ticket price for viewing the film in the cinema would have never watched it and thus if they choose to give HBO Max a try to view that movie and then afterward explore HBO Max library further, I expect a somewhat decent conversion rate there. Box office success has always been a trademark for WarnerMedia with its Warner Brothers Studio and thus the pipeline they have in store is very promising. The next big film that was released was Mortal Kombat and it also enjoyed a great opening with a global total of $50M.
If there is one thing to criticize about HBO Max at this stage, it is the fact that domestic ARPU only stands at $11.72 and thus around 20% below its target price of $14.99. AT&T is providing discounted offerings and bundles to attract customers to its HBO Max flagship and with the above-mentioned strong line-up of films, it has been quite successful in driving customers to the product. The "HBO Max - Retail" segment has grown by 2.8M customers on a sequential basis and these have helped to slightly drive up ARPU from $11.46 for December 2020 quarter to the current level of $11.72.
What's in it for Dividend Investors?
Although AT&T has multiple possibilities to grow its business like 5G, Fiber and HBO Max, we have to acknowledge that we are still facing a pandemic and such all projections need to be treated with additional caution. That said, AT&T recorded record free cash flow of $27.5B for 2020 which is up significantly compared to its revised guidance of around $25.5B. While that is still short of the pre-pandemic free cash flow guidance of around $30B, AT&T has surely generated staggering free cash flow in 2020. For 2021 the outlook now calls for free cash flow to be in the $26B range and a dividend payout ratio in the high 50s. Given that Q1/2021 FCF of $5.9B was already substantially stronger than the $3.9B it recorded in 2020, I consider that to be an extremely conservative estimate and confidently expect AT&T to comfortably come ahead of its guidance for 2021.
Source: AT&T Investor Relations; author's visualization of AT&T free cash flow dividend payout ratio
In any case, as far as dividend safety is concerned that does not really matter. The payout ratio has been between 54% and 60% since 2018 and that range is very comfortable for AT&T to both pay the dividend as well as service its giant debt pile.
As far as debt is concerned, AT&T has been rapidly deleveraging its balance sheet until Q4 2020 when net debt reached $148B. Due to excessive bidding at the C-Band spectrum auction in Q1/2021 net debt jumped $21B, lifting the all-important net debt to adjusted EBITDA ratio from 2.7x to 3.1x and thereby eliminating the progress AT&T has made since 2018. As AT&T projects virtually flat earnings for 2021 that ratio is only expected to come down slightly to 3.0x by end of the year. This sudden growth in net debt pushes the long-term target of a ratio of 2.5x all the way back into 2024 whereas it would have been expected to materialize this year.
Overall, although I am no friend of taking on so much debt, it needs to be said that AT&T can easily service that debt level with 90% of debt being fixed rate and only carrying a weighted average coupon rate of 3.8%.
AT&T remains a free cash flow machine and stands out from most large-cap stocks with its safely covered 6.6% dividend yield. Long-term dividend investors may not like the fact that the most recent dividend hike dates all the way back to December 2019 but the high initial yield should adequately compensate for that as AT&T focuses on debt repayment and executing on its growth areas. AT&T is still a dividend aristocrat and despite a five-quarter streak of stable dividends, AT&T can retain that status if it raises the dividend by the fourth quarter of this year.
AT&T started the year on the right foot with momentum in Mobility and HBO Max defying expectations. AT&T's hybrid distribution model for its 2021 film lineup paid off in that it helped revive theaters and attract more customers to its streaming service.
AT&T's guidance for the full-year appears fairly soft with only projecting revenue growth of 1% and flat expectations and I consider that to be very conservative. AT&T is delivering on its financial commitments by focusing on deleveraging, specifically after the very expensive C-Band auction, and continuing to pay a safe and high dividend currently yielding 6.6%.
AT&T remains one of my largest positions and I am continuing my biweekly savings plan.
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