A $190 billion debt burden, $15 billion in annual dividend payments, a shrinking pay TV business and tough competition in the core wireless business: There’s no doubt AT&T Inc. (T) faces some steep challenges in early 2021, cautions Roger Conrad, editor of Conrad's Utility Investor.
Investor skepticism shines through clearly in the stock’s heavily discounted valuation of barely 10 times expected next 12 months earnings. And the bearishness extends to analysts as well. Bloomberg Intelligence reports just 8 buy recommendations versus six sells and 17 holds.
Just days before the company announced Q1 earnings last week, a Wall Street Journal piece featured the views of a prominent bear under the headline “Is AT&T a Train Wreck.” Among his many criticisms were alleged network under-investment, which he blamed on funding a “nonsensical” dividend.
The company’s Q1 numbers and updated guidance, however, paint a far different picture. That starts with earnings per share more than 10 percent above consensus expectations. Revenue growth swung from a Q4 decline of -2.4 percent to a Q1 increase of 2.7 percent.
Free cash flow after $5.7 billion in gross capital investment shot up 51 percent to $5.9 billion. That was enough to cover the supposedly at-risk dividend with more than $2 billion to spare.
The wireless business added a net of more than a million new customers. Postpaid churn rate dropped and equipment revenue surged as sales continued to recover from the pandemic. And EBITDA margins grew by a percentage point to 57.1 percent of sales.
Business wireline sales dropped by 3.5 percent, offset by 3.6 percent lower expenses. Consumer wireline revenue was basically flat (0.4 percent), as declines in legacy voice and data services were largely offset by 235,000 new fiber broadband customers. The company has now added more than a million fiber users over the past year and expansion remains a priority for capital spending.
Revenue from operations in Latin America sank by 13.6 percent, primarily because of currency losses and pandemic fallout in Brazil and Mexico. These units are likely to remain under pressure this year.
So is the former DirecTV unit, which lost another 620,000 premium video users in Q1 for an annual decline rate of 14.6 percent. Management no longer includes the video business in results, as it’s in the process of spinning it off in a new venture with private capital firm TPG.
The drag from those businesses, however, was dwarfed by the sudden reversal of fortune at WarnerMedia. After shrinking revenue -13.7 percent in 2020 including a 9.5 percent Q4 drop, Q1 division revenue rose by 9.8 percent from the year ago period.
The primary driver was the success of AT&T’s streaming business HBO Max. The company added 2.7 million new US subscriptions during the quarter, reaching a total of 44.2 million. That includes 9.7 million HBO Max users who don’t access the service for free from their cable television provider.
Internationally, customer count reached 64 million, well on the way to comfortably beating an end-2021 goal of 67 to 70 million. Management has targeted 120 to 150 million users by 2025.
WarnerMedia’s overall subscription revenue rose 12.6 percent. Content sales increased by 3.5 percent and advertising revenue rebounded by 18.5 percent, largely thanks to the return of NCAA March Madness.
Looking ahead, HBO subscriptions are likely to remain the primary driver of WarnerMedia’s earnings momentum. But subsiding pandemic pressures should provide strength to advertising. And content continues to get a lift from successful offerings, most recently the action film “Mortal Kombat,” which is based on the 1992 video game.
The company’s “Godzilla vs. Kong” movie earlier this year was a surprise winner with first weekend sales of $32 million. That’s a very solid performance for Warner at a time where overall box office receipts are still running 80 percent below last year. And average revenue per HBO Max user continues to expand, reaching nearly three times Disney’s ARPU in Q1.
The faster WarnerMedia grows, the easier it will be for AT&T to reach its 2021 free cash flow target of around $26 billion. That’s would leave roughly $11 billion after dividends, which management has targeted for debt reduction.
During the earnings call, the company reaffirmed its Analyst Day guidance for $22 billion of CAPEX this year. That’s in line with the $20 to $21 billion arch rival Verizon Communications (VZ) expects to spend and it’s roughly twice T-Mobile US’ (TMUS) plan.
Industry leading CAPEX refutes the charge AT&T has been under investing in network for the sake of its dividend. And the company also continues to showcase ability to raise low-cost capital to fund growth, wrapping up financing for a $23 billion C-band wireless spectrum payment within weeks of its successful auction bids.
Overall refinancing efforts this year have cut its average weighted cost of debt by 50 basis points to 3.8 percent at the end of Q1. That shaved $150 million off interest costs and extended weighted maturity to 16 years.
Judging from the tenor of questions during AT&T’s earnings call, bearish analysts are still pretty dug-in. Some are skeptical about the business model of marrying network with content and believe the company is trying to invest big in too many areas at once. Some maintain it’s lagging far behind T-Mobile and Verizon deploying 5G. And many doubt free cash flow generation is sustainable at levels forecast by management.
By answering these criticisms, Q1 results provided a solid lift for the stock back to the neighborhood of its 52-week high. But only more strong results like these will ultimately free AT&T from the burden of low expectations.
At least one key group of investors is optimistic: AT&T executives and other insiders have been heavy net buyers of their company’s stock this year. Our highest recommended entry point is still 40.
