AT&T: The End Is Nigh (NYSE:T)

AT&T Inc. (NYSE:T) continues to be a name we own, and it just reported earnings. There were some surprises here, and some notable strengths and weaknesses. The quarter was a bit all over the place. Shares are marginally higher, as the Street tries to digest the quarter and the outlook.

We continue to believe AT&T is a great income stock, but do think this market overall has some downside ahead. We really think new money should wait until about $17 to buy, though some may contend it will not get there. The risk of free cash flow not covering the dividend is ending. Provided AT&T Inc. 2023 guidance is remotely hit, the end is nigh for this risk. We shall see. Our main concern is that the dividend is covered, and debt is coming down. Let us discuss.

AT&T Q4 results in context

This earnings season is critical as the markets are looking for direction. Folks, the market is at a crossroads. As it sits right about at the 200-day line on the S&P 500, we are either on the verge of a big breakout, or a turn sharply lower. We tend to think the latter is more likely, but earnings, and then the Fed, will be the ultimate decider.

So far, earnings as a whole have seen less frequent beats, and smaller beats. The outlooks from companies thus far have been mixed. As for AT&T, management is taking action like pricing adjustments, and cost savings measures to preserve margins. We expect to see changing pricing strategies the next few quarters to attract new customers and reduce churn. The company missed very slightly on the top line, and beat on the bottom line.

In our opinion, it seems each quarter that AT&T has improved its financial position. This quarter, they delivered pretty decent results. However, the company has been very promotional to attract customers.

One comment from CEO John Stankey stood out in the release that is bullish:

“We met or surpassed all of our profitability targets for the year all while investing at record levels to bring the benefits of our 5G and fiber technologies to even more people. As we enter 2023, I’m confident in the trajectory of our business and in our team’s ability to deliver profitable and durable growth for our shareholders.”

The company is slowly seeing its financial position improve, while investing in the future. It is a fine line to walk, but management, after years of poor decision-making, is on the right track in our estimation.

AT&T reports a Q4 revenue “miss”

Overall, our revenue expectations for AT&T Inc.’s Q4 2022 were slightly more conservative relative to consensus. Analysts covering the company were targeting a consensus of $31.4 billion. We expected revenue to be closer to the $31.0 billion range on the belief that the company would face declines on revenue with a result of the pressure from being promotional. With $31.3 billion in revenues, this was a beat of $300 million vs. our expectations, but a miss versus consensus. However the miss was trivial, so it was essentially in line.

Revenue drivers

Wireless postpaid growth saw 0.656 million adds, and these were once again boosted by 5G availability and wise promotions put into place. For the year postpaid growth was 2.9 million adds. Very solid results in our opinion. AT&T also reported 0.280 million fiber net adds. Both of these results are strong, and postpaid adds continue to be industry leading. The fiber adds mark the 12th straight quarter of 0.2 million adds or more. For 5G, they are now covering 150 million people. This is double versus what management had previously expected at the start of 2022.

AT&T Q4 earnings outperformance

So the roughly in-line top line performance, which grew 0.7%, helped drive the bottom line to a beat versus consensus in conjunction with cost savings measures. Analysts were looking for $0.57, and this was surpassed by $0.04. Expenses still remain a bit higher than we would like, but we do like the efforts to reduce. Operating expenses were $52.4 billion, but this included a huge $26.8 billion goodwill charge associated with Business wireline and Mexico reporting units. Backing that out, operating expenses were $25.6 billion. While this is down, adjusted for goodwill, from last year and down from the sequential quarter, we need to see these expenses come down even more to maintain and grow earnings. Operating income grew from last year to $5.7 billion, up $700 million. Overall, we are moving in the right direction.

Now, here is the thing. We like AT&T as a dividend play. We still want you to be able to get a better price, and if this market falls hard the next few months like we expect, you will get a better price. That said, we have a very big concern with declining free cash flow. While free cash flow has been more than sufficient to cover the dividend, the cushion of safety has been reduced.

AT&T Q4 free cash flow covers dividend

Free cash flow is key to covering the dividend payment. We targeted Q4 free cash flow would be $5.8-$6.2 billion, considering cash from operating activities of $9.9-$10.4 billion and capex spending of $4.1-$4.4 billion. We were off slightly on our expectations, as cash from operating activities were $10.3 billion, and capex was $4.1 billion, while total capital investment from operations was $4.7 billion. However, free cash flow was at the higher end of expectations at $6.1 billion.

Dividends paid were $2.01 billion, so there was about $4.1 billion in excess free cash flow after the dividend was paid. The payout ratio was a very safe 33.0%. As an income investor for the long term, this is critical. This took the payout ratio for the year to 69.7%.

We think there is room for a dividend hike here, though we want to see debt continue to be knocked down.

AT&T’s debt

The AT&T Inc. debt here is by far the biggest risk to the company, especially with interest rates rising so much. Debt refinancing or new debt taken on will be at much higher rates and increase interest expense. This is a real problem, and one of the biggest risks with holding AT&T stock through this period. But management has been improving the balance sheet by selling off assets and paying down its debt. The net debt was $132.2 billion to end the quarter, with net debt-to-adjusted EBITDA of 3.19X. We will say plainly, the company must do more to get this debt paid down, and that might mean the dividend will be held firm.

Final thoughts on Q4 and the outlook

This AT&T Inc. report was strong, although they did take a massive goodwill charge. It is not all sunshine and daisies here, but the debt to EBITDA ratio is coming down, and the free cash flow was strong. Debt needs to be paid down. As we look ahead to 2023, we see revenue growing 3%-6% on better pricing and more customer adds. We see earnings coming in around $2.40-$2.55 for the year. That puts shares at 8X FWD EPS, pretty attractive. When considering the dividend, management forecasted $16 billion in free cash flow, which means the dividend payout ratio would be around 50% for the year if these metrics are attained. While there is room for a hike, we want AT&T Inc. management to prioritize debt.

Your opinion matters

Do you think AT&T Inc. should prioritize debt? Should they raise the dividend? Should they cut the dividend? That might destroy share prices short-term but protect the balance sheet long-term. Is the stock set to rally this year? Is waiting for $17 too conservative? Have a better name for income to recommend? Let the community know below.