AT&T: 5% Dividend Yield Is Attractive, But Don't Get Fooled By Today's Earnings Beat

| About: AT&T Inc. (T)
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AT&T's (NYSE:T) quarterly earnings were able to top expectations. However, the company still suffered from erosion in its wireless margins due to increased smartphone sales. The net postpaid subscriber additions slowed down as well. The wireline segment is on a consistent decline due to the rising trend toward smartphones, and away from the traditional landline products. We reiterate our previous stance that the stock has limited upside potential based on its valuations, and limited growth potential in a heavily concentrated industry. The stock does, however, remain attractive from a dividend perspective in the current low-yield environment, yielding 5%.

AT&T recently reported its quarterly results, with its quarterly revenues remaining flat year over year. However, its bottom line showed some growth, reporting earnings of $3.64 billion and earnings per share of $0.63 as compared to $0.6 in the third quarter of the previous year.

AT&T Q3 Results



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The company posted solid wireless segment results, despite a few weaknesses in subscriber additions and margins. Total wireless service revenues grew by approximately 5% in the quarter to $14.9 billion, largely helped by increased demand for high speed data by its customers. Wireless data revenues, which include revenues from customers using internet and messaging services, jumped up by almost 20% over the previous quarter, which is also reflected in the company's key metric average revenue per user that showed sound growth over the third quarter of the previous year.

Because of increased smartphone usage by customers and the various data plans, telecom operators have been able to consistently bring about an increase in the revenues they derive from each customer on average. In the quarter recently ended, the company's postpaid ARPU jumped by 2.5% to $65.2. The biggest advantage of carrying smartphones like the Samsung Galaxy S3 and the iPhone 5 for telecom carriers is the fact that it leads to a lower churn, which is the percentage of customers leaving a carrier's network.

The company reported postpaid churn of 1.08%, which is an improvement of 7 basis points over the third quarter of the previous year. That drop in churn further confirms how carrying smartphones is fruitful for carriers, in that it keeps them hooked to their networks. Moreover, the decline in churn was even greater than Verizon's (NYSE:VZ) 3 basis points drop announced recently. However, total churn reported increased in the quarter to 1.34%, largely due to the prepaid segment of the market.

AT&T Q3 Results



Wireless Segment

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Postpaid churn



Wireless ARPU



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Despite overall growth in wireless revenues and improvement in key metrics, there were some weaknesses as well. Even though the company reported an increase in average revenues per user, it added only 150,000 postpaid subscribers in the quarter, which is a significant deterioration (50%) from Q3 2011. Net additions of only 151,000 were disappointing considering the average expectation for net postpaid additions was 358,000. The company suffered from iPhone 5 supply constraints, which resulted in the sale of iPhones to existing customers.

Moreover, compared to the results posted by its rival Verizon a few days ago, the drop in net postpaid subscriber additions is astonishing, as Verizon reported postpaid additions of 1.5 million customers as compared to 0.9 million additions in the third quarter of previous year, which is an improvement of 67%. The company sold 6.1 million smartphones in the quarter, which is a million more than what it managed to sell in Q2 2012. Out of the 6.1 million smartphones, 4.7 million represented sales of the iPhones, which now account for 77% of the total smartphone sales by the company. Increase in the iPhone representation is evident in the fact that sales of the iPhone were 72% of the total smartphone base in the second quarter of 2012, which has now increased to 77%. However, the company also suffered from margin erosion because it sold more iPhones in the quarter. Even though it was widely expected, especially after Verizon reported a slight increase in its wireless service EBTIDA margins, that AT&T would follow with the same result because of a shorter selling period for the iPhone 5. However, AT&T surprised after reporting a drop in EBITDA service margin of 40.8% as compared to 43.7% in Q3 2012.

The company's wireline business continues on its downward trend, reporting a 2% decline in total revenues. Wireless substitution is the major factor at play here, which is leading to a consistent decline in revenues that the company derives from its voice-related services. Voice revenues declined by almost 11% to $5.6 billion in the quarter. However, partially offsetting the 2% decline in overall wireline revenues were the company's U-Verse subscribers, which include TV and Internet customers. Total U-Verse TV customers reached 4.3 million, which is a 23% increase in customer base over the third quarter of the previous year. High speed Internet also provided net gains of 613,000 customers, which help offset DSL losses.

AT&T is trading at 13 times its forward earnings as compared to Verizon's 15 times. On a price-to-sales basis, the stock looks overvalued, trading at 1.6 times it sales as compared to Verizon's 1.1 times. The price-to-sales ratio for AT&T is also at a premium to the same multiple for Sprint (NYSE:S), at 0.4 times.

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

Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.