Is AT&T Stock a Sell Off After Strong Earnings? 6% dividends or 14% earnings (NYSE:T)

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AT&T (New York Stock Exchange:T) rallied slightly after posting an upbeat earnings report. While management appears to be delaying an inevitable cut to 2023 free cash flow guidance, stocks are still cheap here at just 7x earnings. The 6% Dividend performance appears to be adequately covered by earnings, but the company will likely need to pay down debt for many quarters before it can resume meaningful share buybacks. Considering where the rest of the market is trading today, I still can’t recommend buying the stock; instead, I want to see strong execution on debt repayment before committing my capital.

share price

It may surprise some to learn that T shares are trading at the same levels as they were in 1995.

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The last time I covered equities was in August, where I highlighted overlooked management risk. With stocks trading at just 7x earnings, that risk remains ever-present for otherwise cheap stocks.

What were AT&T’s expected earnings?

Consensus estimates called for stagnant gross growth and minimal earnings growth.

Did AT&T outperform profits?

T ended up comfortably exceeding expectations at both the top and bottom.

outweigh profits

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AT&T Stock Key Metrics

Revenue grew 3% (based on independent financial data from AT&T) and profit 9.7%. Management expects to earn at least $2.50 in adjusted EPS this year.

Financial Summary

Presentation of the third quarter of 2022

After the WarnerMedia spin-off, it may be useful to review the current state of the business. I consider that T is influenced by three main drivers. First, its mobility business has provided modest top-line growth with consistent margins.

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mobility results

Supplement for the third quarter of 2022

T has been brought down by the commercial fixed telephony segment facing secular headwinds and considerable margin contraction.

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Supplement for the third quarter of 2022

Those results are offset by the rapid growth of broadband Internet.

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Supplement for the third quarter of 2022

The company expects to generate $14 billion in free cash flow by 2022 against the $8 billion needed to pay the dividend. Management had previously targeted $20bn in free cash flow in 2023, but commentary since then seems less convincing.

And Kannan, on free cash flow, as I said before, we’re not updating our guidance for 2023. But what I did say, we’re more than 3/4 of the way through this year. And based on our view of where the macros are and all the potential risk, we expect this business to grow both in earnings and in free cash next year and for all the reasons that I stated above.

And in terms of the broader macros, look, we’re not immune to them. But these businesses are generally more resilient even in a situation of economic stress. So overall, I mean, that’s… we’ll give you guys an update next year.

Management seemed confident that they will start to see operating leverage result in accelerated adjusted EBITDA growth. Management highlighted its priority to use excess cash flows to reduce leverage to a range of net debt to adjusted EBITDA of 2.5x.

How much debt does AT&T have?

T ended the quarter with $133.5 billion of debt versus $2.4 billion of cash, representing a debt to EBITDA ratio of 3.22x (vs. 3.53x in the prior year, primarily driven by a $27 billion debt reduction ). I estimate the company will need to reduce debt by about $30 billion before reaching its leverage target, which is about five years based on the current $6 billion of retained cash flow after the dividend and assuming zero growth. . Based on the interest savings from debt repayment and some cash flow growth, the company may be able to hit the 2.5x target in four years.

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How is AT&T doing financially?

Everything must be put into perspective. While T is far from growing fast, it continues to generate ample free cash flow and that may be enough considering the low expectations the stock faces. The company has a sizable leverage ratio, but that debt load seems manageable considering the retained cash flow after the dividend.

Is AT&T expected to grow?

Consensus estimates call for minimal revenue growth in the coming years.

consensus estimates

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That additional cost savings is expected to lead to modest earnings growth.

consensus estimates

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Is T-shares a buy, a sell, or a hold?

Bulls can argue that no growth is needed for this reversal to work. The stock is trading at just 7x earnings and a 6% dividend yield.

dividend yield

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Due to the need to pay off debt, this stock may feel more like a 6% earnings yield rather than the 14% earnings yield it is listed at, as shareholders can only get the dividend for the time being. But even then, I suspect many investors would be willing to wait 3-4 years until the debt is paid off and the multiple starts to reflect that progress. I could see stocks trading up to 12x gains as leverage is reduced and share buybacks resume in full force. That reflects about 100% of the potential total return over the next four years.

Here is the problem. Management has a long history of failed mergers and acquisitions, based on broken promises and resulting in persistent debt loads. From DirecTV to TimeWarner, recent acquisitions have not paid off for investors. Long-time investors can attest that the administration has long been promising debt repayment and a reduction in leverage. I think it’s possible (if not likely) that management will identify an M&A target in the coming quarters, leading to leverage rising once again. Given this risk, as well as the lack of share buybacks in the short term, I consider it prudent to wait for the actual execution of the debt payment (I expect the debt to EBITDA ratio to reach 2.8x) before buying the shares, since that this may be “dead money” until free cash flow is returned to shareholders.

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