AT&T: Oh Happy Day

Summary

• 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.

Photo by Presley Ann/Getty Images Entertainment via Getty Images

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.

Data by YCharts

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

Source: yahoo.com

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.

Source: AT&T Investor Relations - Financial and Operational Trends Q1/2021

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.

Investor Takeaway

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.

Analyst’s 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.

I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.

Comments

[deadhead213]

I’m thrilled abt the merger knowing as a shareholder I will still collect a dividend and now receive 71% of a streaming company lead by David Z which will only enhance my portfolio

[ElPablo224]

Dividend to be cut between 46-56%...Are you still happy?

[Stefan Redlich]

@ElPablo224 No, not really. I will rebalance into W.P. Carey I believe if the stock recovers a bit.

[wwn2001]

Well T is holding up relatively well with the rest of the market tanking.

[Throwing Ketchup]

@wwn2001 "Yes, other than that... How did you like the play Mrs. Lincoln?"

[TheWallStreetKid]

Sue2! That's some mighty fine brew you've been drinking. Share with us what brand.

[SUE2]

@TheWallStreetKid As stated-GROW UP.
Aside this morning, 5/11/21 S&P down pre open 1.12%. You need not a stupid mouth but CASH to buy.

[SUE2]

To Stephan.
Living in Germany. Does not really matter but your tax is far different than what exists in the United States. In terms of investments, you can only spend what is NET, after TAXES. The US is one of only a few countries that tax savings, dividends. I'm not sure, I read it years ago. I think Germany is another.
Taxes, world wide, history, REALITY, it is simple. People want, they always have, and they want anyone but them to pay for it. Aside, to all, I am not in the now made evil by HATE a mindless emotion, top 1%.

[Throwing Ketchup]

@SUE2 Here's a thought. I lived in a small city for last 20 years. During that time, as a taxpayer, I helped pay for a new and impressive Middle School, a new court house, a new jail, a new fire house, new city offices, and a new library. They were all needed, as those precious buildings were all well past their useful life, and in some cases, irredeemable. My working-age generation during that time felt put upon, as the previous two or three generations didn't do the work THEY should have done with their tax dollars; THEY preferred to say "NO!" to the work until it had to be done, and all in short order. In other words.... NOTHING much has been done in this country for infrastructure for generations, since Roosevelt and Eisenhower, in some cases. Most of our major airports, railroads, highways, HEALTH CARE, etc., are 3rd World worthy. I don't mind paying taxes toward this stuff, but I'm disgusted with the politicians who've NOT had the guts to do it until NOW and all at ONCE

[Make good choices]

On June 8th 2020, T had a 1 year high of $33.24
Let's see if T will make a new high, or retreat.

[wwn2001]

T on fire! Happy days!!

[TheWallStreetKid]

SUE2 ....May I suggest you stop investing. Go back into knitting or dog walking. Your instincts about stocks are way-off-base. You sold at the wrong time. Try tax deferred annuities or CD's. T is soaring.

[SUE2]

@TheWallStreetKid May I suggest, you grow up. Your post is a clear sign of both immaturity and stupidity. As well as a weak self image.
A suggestion I've never met anyone i can't learn something from.
Sometimes the lesson is not to be like them.
THANKS FOR THE INSTRUCTION.
Oh, reality, I can buy and sell you-CHILD.

[SUE2]

@TheWallStreetKid A part of knowledge. Of GROWING UP is realizing what you do not know and facing it. You might look up the TTM on T.
the PROFIT divided by the number of shares. For T it is MINUS 594.29
They are LOOSING 594.29 per share. The dividend is 6.47%.
What do you THINK is better odds. Whatever the management has said,
which in the real world, not to be confused with High School for the dividend to be cut which will cause the stock to dive or the stock to go up? Once again in case you do not understand. I suggest you grow up.

[wwn2001]

@SUE2 for what it’s worth, IMO his post was condescending and inappropriate.

[SUE2]

I appreciate your view. I hold some (T). The dividend is very enticing. However the company though they say they will not cut the dividend, they are borrowing money to pay the dividend-not a viable business model. I sold my most expensive shares when it hit MY sell price of 31.99. I will ALLOW our government to pay roughly 30% of my loss on those shares. Someone bought them. I hope they do well with them as I still hold far more than I sold.

[wwn2001]

@SUE2 Their dividend coverage ratio is in the 50s and 60s.

[Jstic]

@SUE2 FCF more than covers the dividend. They are not borrowing anything to pay it. Not sure where you are getting your information from but it's way off.

The only time a company borrows to pay a dividend is when FCF does not cover the cost of the dividend payouts. That's when you see a dividend cut. ATT isn't even close to that point as they are only using roughly 60% of their FCF for the dividend. That leaves 40% to pay down debt or other uses.

Don't take my word for it, check for yourself.

[cyoung1]

@SUE2 They have plenty of cash flow for yearly operations (including required principal/interest payments on debt), and-- with what's left over (called Free Cash Flow) they fund the dividend, which takes no more than ~60% of it. The remainder is available to pay down some of the debt, or make small capital investments/ acquisitions. Very large investments, such as the spectrum auction (and years ago, the purchase of Time/Warner), are done almost entirely through new debt, which has brought them to the position they are now- with a high level of debt on the books. Presumably, however, these large investments are few and far between, and in the coming years they can begin to make great strides on retiring a large portion of their debt. In the meantime, those investments should begin to add tremendously to their revenue, helping retire the debt they caused, and add enough value to the overall enterprise that the future AT&T with them in the fold is a much stronger and more profitable company. If all goes as planned, all of our investments in T should be worth quite a bit more 5 or 10 years from now. If not... well, that's the risk you take in order to have a chance for a large return. In the meantime, we get to collect 6-7% in dividends, so I feel it is a risk worth taking.

[cyoung1]

T is the ultimate cash cow, and they were retiring their debt at a pretty good rate-- until they had to overpay for spectrum in the C-Band auction. So, it looks like very little progress is being made. I don't think people are focusing enough on the fact that a one-time expense like that (which they HAD to do) won't happen again for many years- if ever, so unless T goes on another acquisition spree (never say never...), their plan is to now focus on deleveraging, and with the new income streams finally coming in from HBO Max, etc., their debt situation could be very different in just a few short years. I think in a couple of years we’re going to look back on this time as a once in a lifetime buying opportunity. Long T, in multiple accounts!

[fun2roc]

@cyoung1 I believe that there are going to be additional Spectrum Auctions in the not too distant future, and T management has said that they "may" participate.

[GRComments]

@cyoung1 Even if there are future spectrum sales, other competitors will also have to participate to stay competitive. It is a pressure on all of them. As far as other things to buy, I hope that they are more restrained in the future. I would like to see T put in a penny raise at the end of this year to keep up its dividend status and also focus on debt. Retire high interest debt. Pay off as much as possible without sacrificing future earnings.

[earlvv]

@cyoung1 This is a rough stretch for T. They did not raise the dividend because they needed the cash to service the debt incurred for borrowing the cash for the spectrum auction. This tells me that if they do not generate increasing cash the debt repayment will suffer and in time the dividend may actually be cut. I'm not ready to say that is anything more than a possibility at this time and for me to pay strict attention to the quarterly results.
T is in a market that is being disrupted by 5g having the potential to compete with traditional home broadband and fiber. I do not see that as a bad thing, in fact if may help shed costs, but will have a number of bumps along the way. T has expanded it's portfolio of services to help with the reduction of legacy networking, and we need to see results as they leverage this portfolio.

[wwn2001]

T is taking off. Broke out above recent high. Looks like this move higher is for real this time. Bought in at $29 earlier. Get on the T Train!

[craftbrewinfo]

Sold this dog this past winter. Those funds became Home Depot. NOW I sleep well

[wwn2001]

@craftbrewinfo Until it tanks. 2% dividend.

[GRComments]

@craftbrewinfo Bought more this past winter and spring. Sleep well with the capital increase (share price) and the continuing dividend.

[craftbrewinfo]

@GRComments Respect. Not good for me, but to each their own

[Xxfactor]

Why is T tanking right now? Down almost 10% post market?

[mmenchel]

@Xxfactor Really, you think session to session moves tells you anything about any name? Buy index funds, you'll be happier.

[Xxfactor]

@mmenchel mind your own business it was a mistake in sa's system. And yes a 10% drop in 5 minutes is a big deal on a stock that never moves more than a couple dollars

[Tigertom73]

I enjoyed your article. I own 2,500 shares of $T. I bought the shares years ago. I am glad I decided not to sell the shares 5 years ago. $T not much recent growth, but a good dividend payer.

[bearcub1936]

!

[wwn2001]

Just poked over $32. Muuahah

[grharbart201]

I like the info. T is still my largest position by far. GLTA

[TheWallStreetKid]

Are you still a child looking at your favorite toys through the store window and unable to get yourself to walk into the toy store? Paralyzed by your own deficit in Emotional Intelligence? You can change. Think - baby steps. If you miss the next 10 dollars of gain in T you might really feel even more shame. So, my suggestion, respectfully, would be for you to buy 40 or 50 shares of T. You can overcome your own lack of EQ. Take a position - and liberate yourself from your
own self-destructive mentality.

[ba419adv]

Would it make sense for ATT to spin off or sell Time Warner? The debt of ATT would plummet, removing much of the perceived risk. TW would be more like Netflix and Disney and command a much higher PE multiple than as a competent of ATT. Is it time to remove the 2016 merger and realize the two companies are more valuable as two separate companies rather than one.

[ba419adv]

@ba419adv
The TW acquisition was valued at $107.50 per share for $85.4 billion total. At the the time (2017), TW's earnings were about $6.80 per share so the $107.50 purchase price was about 16 times earnings. Netflix' PE multiple is around 60. The S&P 500 PE multiple is about 39. So if TW is still earning what they did in 2017 and we apply a PE multiple OF 35; TW is currently worth $6.80 X 35 =
$238 per share or a bit over double what ATT paid for it. Why is this not reflected in the market value of ATT?

[Oldstockguru]

@ba419adv I purchased AT&T in 1951 and used compound interest with the dividend until they split into eight companies in 1984 and received 7 shares of each of the 7 new companies for each 100 shares of AT&T and kelp my shares of AT&T at a lower value and yes you are correct as my eight companies where much more valuable than one company. That split gave me more money than my family will ever need and I retired in 1984 and still hold all the companies that came our of that split like T, VZ, LUMN & others that all pay me a great dividend every three months.

[geodan85]

Long T and this move may be sustained, technically it looks like a breakout.

However, let's not forget it's the same management (ok different CEO, but essentially the same) that overpaid for Direct TV 6 years ago and cost T ~$50 billion based on the valuation of the sale of a minority stake to TPG (details link below).

www.foxbusiness.com/...

[RealRural]

@geodan85 The idea of a breakout and re-forming the bottom from the long-lamented $27 to say, $30, is a lovely idea. Mr. Redlich might have been timely if not prescient in his analysis. I've long thought market sentiment would respond if TW can begin to show some mojo, and the reopening gambit for the movie theaters and the US in general may be catalysts for T to begin to revert to a more normal P/E and yield.

As someone who is in at $27 and change, the question is whether to add and raise my cost basis and lower my YOC from the very pleasant 8%. One can hope the bargain days are in the rear view mirror and T can put a dent in the debt bears' arguments now that the 5G spectrum auction is over. HBO is advertising like crazy, BTW. Let's hope it works.

[mmenchel]

@geodan85 If reading the technicals is of any use, you must be swimming in profits day to day

[geodan85]

@mmenchel

Sounds like you are a skeptic regarding technical analysis. It's never a stand alone tool and fundamentals trump technicals since they can result in a basis change for a stock's valuation.

However, technical analysis has a self for fulling aspect, if enough people (or computer algorithms) follow it and act upon "signals" it works. Also, every stock has trading ranges after big moves (either way) or are in well defined up or down pattern trends over time, so again it's a useful "road map" when building or liquidating positions.

"Swimming in profits day to day" let's say I had a very successful career as a position trader for a Wall Street bulge bracket firm managing / trading firm capital in the trading book I was responsible for, and to say I didn't look at technicals / charts would be less then honest.

I am retired now, and don't run a long / short book in my personal portfolio or "day trade", but I still range / swing trade my positions by "jobbing" them to manage / adjust cost basis while maintaining core positions in stocks and industries I believe are in sustained up trends in secular bull markets. Within secular bull (or bear) markets they will be cyclical counter trend moves and technical analysis can help you identify and hopefully anticipate these moves or at least figure out when they are exhausted or concluded.