AT&T: Why You Should Be Bullish On This Telecom Titan

| About: AT&T Inc. (T)
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By Morgan Smith

AT&T (NYSE:T), the largest phone company in the United States, reported earnings for the first quarter that exceeded analysts' expectations. The company earned $.60 a share against $.57 a share in the same quarter of the previous year and the consensus estimate of $.57 for this quarter. Total revenues were up 1.8% to $31.8 billion, which was in line with the consensus estimate.

Smartphone upgrading costs were lower than expected, and there was an increase in data sales relating to Apple's (NASDAQ:AAPL) iPad. Compared to the same quarter of the previous year, operating expenses were $25.7 billion compared to $25.4 billion in the previous year, while operating margins improved to 19.2% from 18.6%. Net income was $3.6 billion compared to $3.4 billion in 2011. Operating cash flow was $7.8 billion, and after reducing $4.3 billion for capital expenditure, free cash flow was $3.5 billion.

Wireless operations were characterized by strong sales of smartphones and computing devices, as well as a robust growth in data revenue, better operating margins and decreased postpaid churn. Total wireless revenues including equipment sales were up by more than 5% to $16.1 billion. A significant increase in wireless margins was due to better operating efficiencies, as well as gains in earnings from AT&T's smartphone subscriber base of 41 million users. Wireline operations continue to show an improving trend with improvements in operating margins, even though revenue for the quarter was down slightly over the preceding quarter. The decline in revenues was partly offset by increased cost efficiencies and improvements in consumer and business operations.

Here are some of the more important conclusions that I gathered from the first-quarter results. The increase in wireless data revenues as well as wireless margins is significant for the future performance of the company. Average revenue per user (ARPU) increased 1.7% to $64.46, and this is the 13th successive quarter in which this has happened. It should be kept in mind that smart phone users, on average, spend 90% more than non-smart phone users.

It is also encouraging that 726,000 subscribers were added in this quarter taking the total to 104 million. Both smart phone sales [which exceeded 5.5 million phones] and branded computing devices sales, which include tablets, were quarterly records. Over 60% of the subscribers now have tiered data plans, which would provide better margins in the future. The branded service called U-Verse, which is a triple play of bundled TV, Internet and phone services to 6 million subscribers and I believe that, in the short term, the potential of the service is immense.

What is interesting about the quarterly results of both AT&T and Verizon (NYSE:VZ) is that both carriers have managed to improve their operating margin by selling fewer Apple iPhones. It is clear that the heavy upfront subsidies are hurting the carriers who have compensated by selling other smartphones that have lower subsidies associated with them. For instance, AT&T is pushing the Windows based Lumia 900 from Nokia (NYSE:NOK) in a big way, and Verizon is also trying to reduce its dependence on Apple.

However, the record breaking first-quarter from Apple suggests that Apple is going to continue to skim the cream from the smartphone market. It is extremely unlikely that it would try and do anything for the phone companies. It is also evident that the iPhone has effectively resulted in no increase in contract-based plans (which are the most profitable for telecom companies), and all the growth that AT&T saw came from its sales of tablets.

Despite the phenomenal success of Apple, many analysts believe that the US market is close to saturation and wireless penetration, including devices such as tablets, is believed to be over 100%. As a result, AT&T and its main competitors, namely Verizon and Sprint Nextel (NYSE:S), have no choice but to compete fiercely among the shrinking crowd of Americans who do not own mobile phones at all, while trying to persuade more customers to upgrade to smartphones. They are all banking on the fact that in the long run, user revenues would more than make up for the initial expenses of smartphone subsidies.

From an investor's perspective, I would rule out any investment in Sprint Nextel, which is still losing money as it has done for the last few years. There is now the added complication of the $300-million tax fraud lawsuit brought by the Attorney General of New York. Sprint has emphasized that there is no substance to the allegations but, either way, this is enough to keep me away. Verizon has continued to perform strongly, and it is likely that they would beat consensus estimates again. It is a worthy competitor to AT&T in every respect.

I would imagine that for many investors, a favorite investment would be a stock that has a sizable dividend and low volatility as measured by its Beta. The dividend should be sustainable and there should be prospects of increases over time. AT&T most certainly fits this bill very nicely. It has a Beta of 0.46, which means that it is roughly half as volatile as the market as a whole. This is brought about by its stock price over the last year, which has fluctuated between the upper $20 and the lower $30 figures. It trades at a reasonable earnings multiple and the dividend yield is attractive, being well over 5%. The dividend payout is above 50%, but there is no danger that the dividend is going to be slashed in the foreseeable future. However, this means that there is limited scope for increases in the future.

AT&T is a reliable and solid dividend yield stock of the kind that used to be referred to as a "widow" stock, and you are unlikely to have sleepless nights over your investment. I would recommend buying if you are looking to add a reliable yield investment to your portfolio. If you already have an existing holding in the stock, the yield will compensate you well for holding on and you can add to your holding at price declines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.