AT&T Stock: Free Cash Flow Yield Alert (NYSE:T)

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Getting to the Starting Line

On April 11th, AT&T (NYSE:T) completed the spin-off of Warner Brothers Discovery (WBD). Of course, most T and WBD investors are very aware of this, and even many of the important details.

What’s less well understood is how valuation and price have been shifting rapidly in a strange market, or at least weird market conditions. We’ve got war, inflation, supply chain issues and more.

So, we shall take a look at T’s valuation and price, and leave WBD for another day. In other words, WBD is only mentioned here to give more context for T. In this article, we’ll see why now might be a good time to accumulate T. The specific emphasis will be free cash flow yield stability, and maybe even growth.

Something Weird Happened

Let’s take a look at T versus WBD, just for a quick minute.

Chart
Data by YCharts

I’ve argued that T investors haven’t done well with their WBD. And, as I’ve previously spelled out:

…there was never a good time to sell T once we found out that WBD was getting spun off. If you sold immediately, you’d be down since T’s price was already suppressed by the market. And, if you held, your dividend was cut, and you got WBD. Since WBD is down, you’ve lost money. In other words, your dividend income is down, and your capital has been eroded.

Furthermore, I feel that it’s still true, or even more true than when I explained this back in the middle of May 2022. In short, T investors who also hold WBD should probably continue to hold WBD, versus selling. WBD’s assets are wonderful and in the long run, it’ll likely do just fine. So, that’s what I’m doing in light of all the data I’ve seen; plugging my nose, holding my WBD.

AT&T Has (Recently) Beat the Market

The bigger point for this article is that T has held its price. The market has neither rewarded nor punished T for the WBD spinoff, at least in this short period of time. I think that’s good news, especially given this picture of the S&P 500 (SPY).

Chart
Data by YCharts

I see T as a lighthouse of sanity amid a sea of chaos. Once again, I’m only looking at this since the WBD spinoff, to maintain clarity between our charts. Nevertheless, T has barely moved whereas the market is off more than 16%.

What’s not entirely clear is why T is holding its price, while WBD and the broad market via SPY. My broad view is that there is a shift to the physical world. I try to remind myself that although T is a technology company, it’s also a communications company with a tremendous physical footprint.

  • Fiber
  • Direct TV
  • Wireless
  • 5G
  • U-verse

This list goes on and on. Obviously, there are a ton of services on top of this infrastructure as well. But really, T is well-positioned in the “real world” with their physical assets. Combined, we have a strong cash flow company, albeit with a hefty load of debt. Yet, their credit ratings are just fine.

AT&T DEBT RATINGS

AT&T DEBT RATINGS (AT&T Investor Relations)

Now it’s time to talk about T’s valuation problems over the last 5-10 years. This should be viewed in simple terms here, in terms of price.

AT&T Found the Bottom

First, a quick picture, with a long view.

Chart
Data by YCharts

Some observations and notes include the following:

  • T has been on a steady decline for 10 years.
  • T is not the same company as it was 10 years ago.
  • T’s price swings up and down quite a bit over time.

But, this is backward-looking, and it’s only a view of T’s price. How about value? What do we know? Well, as Morgan Stanley points out:

AT&T is guiding for expansion of free cash flow in 2023 and beyond, both through growing adjusted EBITDA and cutting capital expenditures. EBITDA is expected to grow 6% in 2023, accelerating from 3% growth this year, and capex is expected to fall by nearly 17% in 2024 to $20 billion, with the relaxing of 5G rollout spending.

It’s this cash flow growth that also gets me excited about T’s future. It provides the business with tremendous opportunities, from paying down debt to increasing growth, to rewarding shareholders with growing dividends.

Ignoring WBD, again, we know T is surprising investors:

The company added a net 965,000 postpaid subscribers, and 691,000 postpaid phone net adds, beating expectations. On the wireline side, AT&T Fiber added a net 289,000 subscribers, with penetration up about 2 percentage points to 37%.

And, T is trying to position for inflation, to keep the business moving faster, or at least keep the dynamic with customers reasonable all around:

We went to a simplified price structure, I want everybody to understand what this means. We are not out in the market right now selling on 12-month promotional pricing on broadband. We are selling the customer on a stable price to the duration of the relationship with us.

But I really want to return to this, from T’s CFO, Pascal Desroches:

Now, let’s take a step back and look at the free cash flow generation expected from our business. As outlined at our Analyst Day, we expect to generate in the range of $20 billion of free cash flow in 2023. After paying dividends and non-controlling interest commitments, we expect to have at least $10 billion of cash remaining. [Emphasis: Author]

Adding it all up, and T’s growing in terms of both subscribers, but also free cash. The business is also navigating through the pain of inflation and has room to stay on pace, reasonably well.

As Bloomberg reports:

AT&T’s increases are the first for such plans in three years. The Dallas-based carrier is raising monthly fees on those older packages by up to $6 a month for single-line customers and up to $12 a month for families, a spokesman confirmed Tuesday.

In any event, doing some extremely rough math, we can derive free cash flow per share, in 2023. We’ve been told that T ought to be pulling in $20 billion in free cash flow, and with about 7.2 billion shares outstanding we’re looking at roughly $2.80 in FCF per share in 2023. So, with T trading at around $20, we’re looking at a 2023 FCF yield of 14%. If we’re being conservative, I think we’re probably looking at something like a 11-12% FCF yield.

As a sanity check, I took a glance at YCharts to see if my back-of-napkin math made sense. Well, here’s some good news:

Chart
Data by YCharts

What I see is that I’m definitely in the right ballpark, playing the right game. Furthermore, and interestingly, T’s been improving FCF yield for a long time. Like most investing, however, it’s a bit choppy. Nevertheless, seeing T with an FCF yield above 6% for such a long time is good news. And, expecting 14% into 2023 is also positive news.

Wrap Up

I must make a few points to be fair all around. I’ve been hard on T at times, especially management, because of how investors haven’t done well with WBD. As many of you are guessing, that will likely work out fine if you’re still holding WBD after the spin off. Time will tell.

I’ve also been hard on T because of how things have worked out with the dividend. That is, my own dividend cash flows were impaired when T decided to spin off WBD, and the dividend was cut. I had to “heal” that dividend, which was annoying, but the job is done. Compounding is a beautiful thing, and T is merely one piece of my portfolio.

With all of this behind us, what I’m seeing is that T has likely found a bottom. They are now more focused on the core business. More importantly, I think, is that T is working through the macro issues. They are also now flexing their rather large oligopolistic muscles. Few can do what they do with pricing, when they want. I’m also excited by T’s strong FCF and FCF yield, in 2022, but also into 2023.

This bigger picture thinking, and looking beyond WBD, gives me confidence in a buy rating for T. My caution is that the markets are still a mess, and the price could drop, but probably not anything too crazy. Yet it could happen. So, the prudent approach is likely to start a small position and dollar cost average. Or, for longer-term investors, just dollar-cost average. This is all to account for any real downside break in the entire market.

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