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For many years here at Seeking Alpha, AT&T (NYSE:T) has been a popular battleground stock between dividend investors, and bears that believed the company was going under. There has been so many developments in the ten years since our firm has been writing at Seeking Alpha. This piece that you are reading puts us just past the 2,500 article mark for the company, just as we hit our ten year anniversary. The amazing thing is that we have been bullish to neutral on this stock that entire time, only recently becoming concerned short-term following the just reported earnings. This is because the report, in our opinion, was mixed at best, while the guidance was unlike anything we have ever seen from the company. Is this company worth owning long-term? In our opinion you will continue to see short-term pressure. The market rallied hard the last week, and T stock did nothing, like a zombie. But that is because traders are not sure the company will deliver. Even the super safe dividend could be in jeopardy if the situation worsens. But we think that the next severe dip from here can be bought by long-term investors. Let us discuss.
Bearish short-term, bullish long-term
So we are in a world now post spinning the off of the WarnerMedia assets in the recent merger. Even though we think short term the market will crap on T, we have long held this as a dividend paying name, and will continue to do so. The fact of the matter is that if you hold this one long enough, you likely CANNOT LOSE MONEY.
Now why on Earth would we even make a statement like that? Ok, nothing is certain, but the company through the highs and lows, through thick and thin, has continue to pay its dividend. Depending on where you buy, it may take 10 or even 15 years to do it, but eventually, you will get all of your initial investment back through dividends, so long as the company does not go belly up. Despite a sizable debt, this company is not going anywhere.
One of the biggest risks with holding AT&T has continued to be the debt. Management has been tackling debt and improving the balance sheet by selling off assets and paying down its debt. Since the spinoff debt has come down, but it is still eye-popping. At the end of the second quarter, net debt was $131.9 billion. This means there is a net debt-to-adjusted EBITDA of 3.23x. Keep this risk in mind, but as long as debt is paid down, we focus on income potential here.
Right now, if you bought 1,000 shares here at $17.50, It would take 15 and half years to get your entire investment back, assuming the dividend of $1.12 annually is maintained and never raised (or cut). Sure, that is a LONG TIME. But it is factual. Everything you get after this time period is gravy. It is ‘free money’. That assumes no capital gains or losses too. Lot of assumptions, but you get the point.
For income investors, the question of where a bottom is naturally comes to mind. We think this mid-teens level is close, and think any further weakness should be bought, even if the company had horrific news for us. The dividend is not getting cut, even if there are cash flow woes, which we will discuss. Hold your nose, let the Street knock this down short-term, and do some buying. We are bearish short-term, but long-term bullish. Let us discuss.
The Q2 results were good at first glance
The company’s results were decent at first glance. With the economy on shaky ground and the consumer becoming fickle, business spending is in question now. It could get worse before it gets better and management is taking proactive measures, such as selective pricing adjustments, to address as much of the very real inflationary pressures that are out there. Due to inflation the company is experiencing massive cost pressures in its business, and in fact saw $1 billion more in costs than it thought it would have. That is huge.
As we come into a new challenging time for the company, we do note that it has improved its financial position, but there is much more to do. We believe management must accelerate cost savings programs. We think the company will be getting even more promotional to attract customers. That said, the results were good at first glance.
This comes as our revenue expectations for Q2 2022 were slightly more conservative relative to consensus. Keep in mind the analysts covering the company had a consensus expectation of $29.47 billion for Q2. We expected revenue to be higher and in the $29.75-29.8 billion range. We felt that despite the increase in inflation the economy was still firing in Q2. We expected strong demand from businesses and consumers, given that unemployment remained so low during the quarter. In addition, the services of the new leaner AT&T are not really discretionary. At this point, the world relies on cell phones, internet connections, etc. Well the top line hit $29.60 billion, much better than expected vs. consensus but lower than we expected. So while it missed out view the result was a beat of nearly $130 million vs. consensus. As we drilled down we saw the best Q2 for postpaid adds in the ten years since we have been writing about the company. Wow. They saw wireless postpaid growth saw 0.813 million adds and another 316,000 Fiber net adds. For 5G, they are now on track to hit 100 million people. That is eye popping when the goal for year-end was 70 million. Impressive. Even earnings were strong.
Earnings were strong too
The strong top line revenue performance helped drive the bottom line to a beat versus consensus. Just how good? It was a solid beat. Analysts were looking for $0.62, and this was beaten by $0.03.
The thing is, despite this beat, we think expenses are too high, offsetting the revenue somewhat. Operating expenses were $24.7 billion. While this is down from last year, recall the major divestitures that have taken place. Operating income fell to $5 billion, though adjusting for one-time and special items the operating income really expanded slightly to $5.9 billion from $5.7 billion, accounting also for the divestitures. So that was good. But where we started to see pain was in the most important metric we follow. And that is free cash flow. It was a disaster really. An absolute implosion in expectations. This is why the stock is acting like a zombie short-term. Ouch.
Free cash flow expectations have been obliterated
This is still an income stock, but with income stocks, we always look to the free cash flow generation of the company. It is just critical. Our members know that free cash flow is everything for these kinds of names. So key. If free cash flow looks to improve, the stock tends to rally. Well the stock has fallen badly, and it is almost entirely due to free cash flow and the expectations for less of it in the future. That is not good right now.
The reason that free cash flow is so important is that free cash flow is really how the dividends that are paid are covered. When the company pays more than it brings in, it slips further on the balance sheet. For years the dividend was being comfortably covered by free cash flow. No trouble at all. And, with this mindset and looking at performance and expectations, we thought Q2 free cash flow would be in the range of $2.0 to 2.5 billion, considering cash from operating activities of $7.0-$7.5 billion and capex spending of $4.5 billion.
Well, we were off slightly on our expectations as cash from operating activities were $7.9 billion, and capex was way up to $4.9 billion, while total capital investment from operations was so much higher than expected at $6.7 billion. This led to a nosedive in free cash flow at $1.4 billion. This is why the stock has been hit. But it was not a one-time issue. Ouch. We expect revenue to improve, but cash flow was guided by management to be just $14 billion for the year. This should still cover the dividends to be paid of about $4.2 billion for H2 2022, considering free cash flow thus far was $4.2 billion. That means we can expect another $9.8 billion in free cash flow if the forecast is correct, meaning the dividend is covered, but the margin of safety is not so good. Here in Q2 dividends paid were $2.09 billion, so there was about a $700 million shortfall. As an income investor for the long-term this a red flag. So you must watch to see if cash flow generation improves from here.
Final thoughts
This is an income name that we have covered over the last ten years. It has had a lot of ups and downs, with some serious debate in the comments section. We had felt the stock would pull back to the mid-teens. We still think $15 is where we would be heavy buyers. The market rallied so hard, and T stock did not do much. Bit of a zombie stock of late. Seeing the dividend barely covered for the year is definitely a concern. If the macro situation worsens, we could see another guidance cut. All eyes must be on cash flow from here on out. We believe that this current downturn could be a strong buying opportunity. Let the bears walk it down, then do some buying for the long-term
What do you think?
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