Many years here at Seeking Alpha, AT&T (NYSE:T) was a popular battleground stock between dividend investors and bears who believed the company was going under. There have been so many developments over the past ten years since our company writes at Seeking Alpha. This piece you are reading sets us just over the 2,500 item mark for the company just as we were celebrating our tenth anniversary. The amazing thing is that we have been bullish-to-neutral on this stock all along and only recently became short-term concerned just reported earnings. This is because we felt the report was mixed at best, while the guidance was unlike anything we’ve ever seen from the company. Is this company worth owning for the long term? We think you will continue to see pressure in the near term. The market rallied strongly over the past week and T-Shares did nothing like a zombie. But that’s because traders aren’t sure the company will deliver. Even the super-safe dividend could be in jeopardy if the situation worsens. But we think the next major drop can be bought by long-term investors from here. Let’s discuss.
Bearish in the short term, bullish in the long term
So we’re in a world that’s now at the recent merger following the spin-off of the WarnerMedia assets. While we think the market will shit on T in the short term, we have long held this name as a dividend-paying name and will continue to do so. In fact, if you hold this one long enough, you probably CAN’T LOSE MONEY.
Why on earth would we even make such a statement? Okay, nothing is certain, but the company has continued to pay its dividend through ups and downs, through thick and thin. Depending on where you buy, it could take 10 or even 15 years, but you’ll eventually recoup your entire initial investment in dividends as long as the company doesn’t collapse. Despite racking up significant debt, this company isn’t going anywhere.
One of the biggest risks in owning AT&T continues to be its debt. Management has addressed debt and improved the balance sheet by selling assets and paying down its debt. Since the spinoff’s debt has dropped, it’s still a head turner. At the end of the second quarter, net debt was $131.9 billion. This results in a ratio of net debt to adjusted EBITDA of 3.23x. Keep that risk in mind, but while the debt is paid off, our focus here is on the earnings potential.
Right now, if you bought 1,000 shares here at $17.50, it would take 15.5 years to recoup your entire investment, assuming the $1.12 annual dividend is maintained and never increased (or cut). Sure, that’s a LONG TIME. But it’s factual. All you get after that time is gravy. It’s “free money”. This also assumes no capital gains or losses. Lots of assumptions, but you get the gist.
For income investors, the question naturally arises as to where a bottom is. We think that mid-teens level is close and think any further weakness should be bought even if the company had terrible news for us. The dividend won’t be cut, although there are liquidity issues, which we’ll discuss. Hold your nose, let the street slam momentarily and shop. We are bearish in the short-term but bullish in the long-term. Let’s 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 consumers getting cranky, corporate spending is now in question. It could get worse before it gets better and management is taking proactive measures such as: B. selective pricing to address as much of the very real inflationary pressures that are out there. Due to inflation, the company is under massive cost pressures in its business and actually saw costs exceeding $1 billion than expected. That’s huge.
As we enter a new challenging time for the company, we find that it has improved its financial position, but there is much more work to be done. We believe management needs to accelerate cost savings programs. We believe that the company will do even more advertising to attract customers. Nevertheless, the results were good at first glance.
This is because our revenue expectations for the second quarter of 2022 were slightly more conservative compared to the consensus. Recall that the analysts covering the company had a consensus expectation of $29.47 billion for the second quarter. We expected higher revenue in the range of $29.75 billion to $29.8 billion. We felt that the economy was still going strong despite the rise in inflation in Q2. We expected strong demand from businesses and consumers as unemployment remained so low during the quarter. Also, the new slimmer AT&T’s services aren’t really discretionary. At this point, the world is dependent on cell phones, internet connections, and so on. Well, revenue hit $29.60 billion, way better than expected versus consensus but lower than we expected. Though it missed the prospect, the result was a nearly $130 million hit to the consensus. Coming down, we saw the best second quarter for postpaid additions in the decade since we’ve written about the company. Wow. They saw growth of 0.813 million wireless postpaid adds and an additional 316,000 fiber optic adds. For 5G, they are now well on their way to reaching 100 million people. That’s staggering considering the goal for the year-end was 70 million. Impressive. Even the gains were strong.
Profits were strong too
Strong top-line revenue performance helped the bottom line beat consensus. How well? It was a solid beat. Analysts were looking for $0.62 and it was beaten by $0.03.
The thing is, despite this beat, we feel the expenses are too high and the income is somewhat offsetting. Operating costs were $24.7 billion. While this is down from last year, remember the big divestments that took place. Operating income fell to $5 billion, although operating income, after adjusting for one-time and special items, actually increased slightly to $5.9 billion from $5.7 billion, which also includes divestitures. That was good. But where we started to see pain was in the key metric we follow. And that’s free cash flow. It really was a disaster. An absolute implosion of expectations. Because of this, the stock is behaving like a zombie in the short term. Ouch.
Free cash flow expectations have been wiped out
This is still an income stock, but with income stocks we always look at the company’s free cash flow generation. It’s just critical. Our members know that free cash flow is everything for this type of name. So key. When free cash flow appears to be improving, the stock tends to rally. Well, the stock has fallen sharply, and that’s almost entirely due to free cash flow and expectations that it will slow going forward. Now that’s not good.
The reason free cash flow is so important is because free cash flow is really how it covers the dividends it pays. If the company pays more than it earns, it slides further down the balance sheet. For years, the dividend was comfortably covered by free cash flow. No problems at all. And with that thinking, and given the performance and expectations, we assumed that second quarter free cash flow would be in the range of $2.0 billion to $2.5 billion, accounting for cash from operations at 7.0 to $7.5 billion and capital expenditures of $4.5 billion.
Well, we were slightly below our expectations as cash from operations was $7.9 billion and capital expenditures grew well to $4.9 billion while total capital investments from operations were $6.7 billion -dollars were so much higher than expected. This caused free cash flow to plummet to $1.4 billion. Because of this, the stock was hit. But it wasn’t a one-time problem. Ouch. We expect sales to improve, but cash flow has been projected by management at just $14 billion for the year. That should still cover about $4.2 billion in dividends to be paid for the second half of 2022, considering free cash flow has been $4.2 billion to date. That means we can expect another $9.8 billion in free cash flow if guidance is right, which means the dividend is covered but the margin of safety isn’t that good. Here in the second quarter, dividends paid were $2.09 billion, so there was a deficit of about $700 million. As a long-term income investor, this is a red flag. So you need to watch if the cash flow generation improves from here.
This is an income name that we’ve covered for the past decade. It had many ups and downs, with some serious debate in the comments section. We had believed the stock would fall back into the mid-teens. We still think we would be strong buyers at $15. The market rallied so much and T-Shares didn’t do much. Quite a zombie population lately. To see that the dividend for the year is barely covered is definitely worrying. If the macro situation worsens, we could see another guidance correction. All eyes must be on cash flow from now on. We believe this current downturn could be a good buying opportunity. Let the bears do it, then buy for the long term
What do you think?
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