AT&T: The Market Is So Wrong Here

Summary

• AT&T Inc. stock experienced a selloff in recent weeks and currently trades close to its 6-month low.
• Despite reporting decent results for Q1, the market didn’t like the fact that AT&T generated minimal free cash flow during the quarter.
• The good news, though, is that there are reasons to believe that AT&T should be able to exceed expectations in the following quarters.
• If that’s the case, then there’s a possibility that AT&T stock would recover and create additional shareholder value in the foreseeable future.
• Looking for a helping hand in the market? Members of BlackSquare Capital get exclusive ideas and guidance to navigate any climate. Learn More »

Ronald Martinez

Despite reporting decent earnings results for Q1 and beating the street estimates a couple of weeks ago, AT&T Inc. (NYSE:T) stock nevertheless experienced a selloff and trades close to its 6-month low to this day. While the market didn’t like the fact that the company generated minimum free cash flow ("FCF") during the March quarter, there are nevertheless reasons for optimism, as AT&T has all the chances to improve its overall performance in the next few quarters. This would likely lead to the creation of additional shareholder value in the foreseeable future.

Market Fears Are Overblown

The Q1 earnings results that AT&T revealed in late April showed that the company generated $30.14 billion in revenues, up 1.4% Y/Y, while its non-GAAP EPS was $0.60. At the same time, the postpaid average revenue per user increased by nearly 2% to $55.05, while the postpaid and prepaid churn rates were 0.81% and 2.73%, respectively. Such results indicate that AT&T still has the ability to grow and retain subscribers even in the current environment despite all the chatter about how its business is dying. There’s even an indication that the company would be able to continue to exceed top line expectations in the following months.

However, despite those results, AT&T’s stock has experienced a major selloff in recent weeks and currently trades close to its 6-month lows. This is due to the fact that AT&T generated only $1 billion in FCF during the quarter, below the expectations of nearly $3 billion. While at first this might seem like a big deal, I would argue that the recent depreciation of the company’s shares is unjustified.

While the FCF came in below the initial target, AT&T nevertheless is on track to reach $6 billion in cost savings, as it’s in the middle of optimizing its business in the post-Warner Media era. At the same time, the $6.4 billion in capital expenditures in Q1 for fiber and 5G projects have the potential to help the company revive the growth story and yield greater returns in the following years. In addition to that, AT&T’s management still expects to generate $16 billion or more in FCF in FY23 due to the forecasted better returns in the next few quarters.

Considering that in FY22 we faced a similar situation where FCF was weak in the first half of the year but later improved by year-end and helped the management reach its target, there’s a high possibility that the same scenario will unfold in FY23. If that’s the case, then the recent selloff is unjustified.

In addition to this, AT&T was also able to strengthen its balance sheet as the long-term debt decreased from $132.9 billion in Q4’22 to $123.4 billion in Q1’23. On top of that, by having an interest coverage ratio of nearly 4x while 95% of its debt is at a fixed rate of 4.1%, the company will likely be able to continue to service its debt without any problems despite the rising rate environment. Add to this the fact that AT&T continues to generate positive FCF at a time when it substantially decreases its debt and pays ~$2 billion per quarter in dividends and it becomes obvious that the company is able to continue to create additional shareholder value in the foreseeable future.

That’s why I think that the latest selloff is unjustified. The good news, though, is that at the current market price, AT&T’s stock now offers a good entry point for new investors, as its dividend yield at the current levels is over 6% while the downside is relatively limited.

What’s Next For AT&T Stock?

In addition to various growth opportunities, there’s also an indication that AT&T’s stock is undervalued solely based on the fundamentals and could create additional shareholder value in the following months. To figure up how much of an upside the company offers at the current levels, I’ve updated my discounted cash flow, or DCF, model. It may be seen in the table below.

The assumptions for the revenue and earnings in the model for the next couple of years are mostly in line with the Street and management’s outlook. The assumptions for other metrics are also similar to my previous model, which was published in late March before the release of Q1 results. The WACC rate in the model stands at 9.50%, while the terminal growth rate is 3%.

AT&T's DCF Model (Historical Data: Seeking Alpha, Assumptions: Author)

The updated model shows that AT&T’s enterprise value is $272.8 billion while its fair value is $20.37 per share, which represents an upside of ~20% from the current market price.

AT&T's DCF Model (Historical Data: Seeking Alpha, Assumptions: Author)

In addition to my valuation, the Street also believes that the latest selloff is unjustified as the company is likely to improve its overall performance in the coming quarters. As such, it gives AT&T’s shares a consensus price target of $21.31 per share, which indicates that the upside could be even greater than my calculations suggest.

AT&T's Consensus Price Target (Seeking Alpha)

Risks To Consider

Despite all the upside, there are nevertheless a couple of risks that investors need to consider. First of all, the potential recession could bring the AT&T Inc. share price even lower despite all the growth catalysts and strong fundamentals.

At the same time, while the debt situation is currently manageable, if the Fed overdoes the tightening and crushes the economy then there’s a risk that AT&T could fail to meet its performance targets and could even generate a negative FCF. While it’s unlikely that that’s going to be the case, there’s nevertheless a risk that under such a scenario the questions would be raised about the potential elimination of dividends to continue to service the debt and improve the balance sheet. Even though I don’t think that’s going to happen in the distant future, a hard landing or a black swan event could nevertheless lead to such a scenario. Investors need to be aware of it before deciding whether to hold AT&T’s shares in the portfolio.

The Bottom Line

While the decline of FCF in Q1 disappointed the market, there are nevertheless reasons to be optimistic about AT&T’s performance in the foreseeable future. Thanks to various growth catalysts, AT&T Inc. has everything going for it to generate better returns and exceed its expectations in the next few quarters and reach its FCF target for the year. Add to this the fact that AT&T Inc. shares are undervalued after the recent selloff and it becomes obvious that the business’s stock has all the chances to create additional shareholder value in the following months despite all the risks that are unlikely to materialize in the following months.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Bohdan Kucheriavyi and/or BlackSquare Capital is/are not a financial/investment advisor, broker, or dealer. He's/It's/They're solely sharing personal experience and opinion; therefore, all strategies, tips, suggestions, and recommendations shared are solely for informational purposes. There are risks associated with investing in securities. Investing in stocks, bonds, options, exchange-traded funds, mutual funds, and money market funds involves the risk of loss. Loss of principal is possible. Some high-risk investments may use leverage, which will accentuate gains & losses. Foreign investing involves special risks, including greater volatility and political, economic, and currency risks and differences in accounting methods. A security’s or a firm’s past investment performance is not a guarantee or predictor of future investment performance.

Comments

[Brent Ericson]

how does this stock just keep going lower and lower everyday? Even in an up market?!

[Michael Hooper]

@Brent Ericson ATT is a loser dog stock. There is a flight to safety right now and that means solid stocks like consumer, defensive stocks, like PepsiCo, Coca-Cola, Hershey, these companies have great margins, and can raise prices and people will still buy their products. the pricing pressure in the cell phone world, and the streaming world is very intense and a ATT is, an amalgamation of many problems, too much debt, not enough revenue, terrible margins, a white elephant in the 5G build out. All of these just say no no no I’m gonna put my money somewhere else. Thus the stock Falls.

[zionking12]

Does $T management ever read some of these comments? Just wondering why most of the comments here on Seeking Alpha knows a change in management and new strategic direction is needed but it seems like the current board and management of AT&T are blind about that and paying themselves 'FAT" bonuses and compensation for lack of growth and mismanagement of the company. My questions is what are $T shareholders doing about this issues?

[arete_builders]

@zionking12 T is essentially an unregulated utility. If you are looking for growth, it’s a bad place to be (see the WBD acquisition as a misguided attempt to. Relate growth).

But an undervalued utility with a 6% yield isn’t the worst place to put cash to work.

[Gustave Eiffel]

Thanks for your time and analysis. ATTs stock is clearly on a slow decline and has been for many years. It is, essentially, a sinking ship. Do yourself a favor and answer these questions truthfully. Are ATTs Cash Flows positive or negative? What’s the debt load of ATT? What are the growth opportunities for ATT? Over the recent past has ATT raised or cut its dividend and, if so, why? What about the long-term trend for the stock, is it up or down (what story does it tell)? Does ATT have a competitive advantage? In short, are the dividends safe? Having said that, would you be better off buying 5%+ treasuries/brokered CDs for your portfolio of which incidentally are guaranteed or buying a sinking ship such as ATT for its dividend?

Otherwise, keep up the good work. Gustave.

[Rhoda711]

Good info, thank you. I bought at 17, so I’m not unhappy. I plan to add on dips.

[whatsfordinner]

Doesn't T have a tremendous amount of debt and when it reprices under this admin all the costs of funds go UP! That can't be helpful and even feeds inflation. Where is the inflation reduction act I've heard touted over and over by democrats.

[Fangorn]

@whatsfordinner Didnt he answer the above?

"AT&T was also able to strengthen its balance sheet as the long-term debt decreased from $132.9 billion in Q4’22 to $123.4 billion in Q1’23. On top of that, by having an interest coverage ratio of nearly 4x while 95% of its debt is at a fixed rate of 4.1%, the company will likely be able to continue to service its debt without any problems despite the rising rate environment"

[whatsfordinner]

@Fangorn As I recall I have read articles contraire.

[apragmatist]

@whatsfordinner Gas is down over a buck vs. last year! Inflation overall is coming down albeit moderately but consistently for the same time frame. Try reading the reports monthly!

[TZo6]

I’ve owned T for going on 5 years now and it has done nothing but go down.

[Et20]

I prefer non US carriers. Softbank, Telus, Orange, CHT etc.

[usedcarguy]

Why would anybody by T when you can buy a pipeline stock with the same yield and without crippling debt, crippling management, and more than enough cash flow to support and grow the dividend?

Owning T is the equivalent of death by 1000 papercuts.

[Elon beat me with jumper cables]

Mangement, management, management.

[chuckles]

@Elon beat me with jumper cables T has had bad management for 20+ years, yet every election they get re-elected. They have been elected to dismantle T and ruin the company. How tough can it be to just take billions of dollars and sit on them for interest for 20 years? They can't do it! They feel like they have to do something to "add value" and screw it up by the numbers. I can't remember a good deal they have made in 20+years, yet we can't seem to get them fired.
I wonder if Black Rock is secretly running the show behind the scenes trying to make them "DEI" like Disney, Budweiser,XOM, and others? I own XOM and their board has them dedicated to being out of the oil business in 10 years. The board was forced to hire these idiots from an outside group. I think Black Rock now owns about 70% of the S&P.

[jakeelwood5]

Is 5G making any money for any of these companies? I look at T as a bond substitute and utility going into a recession.

[VoiceofSanitySometimes]

Why would you risk your hard earned money to bet on bad management?

Put your money into well-run companies. No guarantees, but your odds are a lot better.

[Ishi Kenjo]

The market was wrong when T was at $30. $17 might be kind. If they could get rid of Stinky & the rat infested board things could improve. Until then a loser!

[Michael Hooper]

@Ishi Kenjo AT&T has been a loser company for a long time. I remember an earnings call many years ago. The earnings were no good but they bought a small company and touted that at the earnings Call and investors seemed to like it so the stock bumped up. The reality was cash flow was horrible. Debt was rising and earnings were not growing at all. But hey look, we got this new company! Bullshit.

[Ekanova]

The Market is always right.

[Brent Ericson]

just when you think things are getting better, all the gains are gone.

[Code Talker Market Analysis]

The market is pricing in a recession. This is what it should do. $T is not going to make extra FCF each quarter in a recession.

[Brucejfern]

The market doesn't get it wrong. The market is the market and T missed its own free cash flow estimates and that disappointment is what dragged T down.

[spike5]

@Brucejfern not true. They are on target. Analysts over projected Qtr 1 FCF. I guess they were not paying attention in the 4th Qtr CC.

[Jlexus1953]

T has a perception problem magnified by its disastrous past mismanagement that intensifies every future mistake. Management never identified prior to the first quarter earnings announcements that FCF would miss and miss badly. It gives the impression that management is not managing or is hiding something. Regretfully I am a long long time T owner and have suffered through years of poor decisions. The stock is where it is for a reason and will not move until management is transparent and produces results that exceed forecasts

[David Jonas]

And I might suck in my gut, shave my back & get 30 minutes in a Motel 6 with J-Lo. It can happen.

[William- Billy Hill]

T's senior management and Board have been sleep walking for 15+ years. Look at the history of the share price for confirmation. Management and the Board have no credibility with the market. They created the problem and now must live with it. The shareholders would be better off in a CD.

[ziggyzig]

I was laugh at and ridiculed when I said go short at 33.00 and it could see 20.00. Now I think it may see 12.00 on a recession. By the way what does the Dividend cost per Q ?