Getting to the starting line
On April 11, AT&T (NYSE:T) directed the Warner Brothers Discovery (WBD) spin-off. Of course, most T and WBD investors are very aware of this, and even many important details.
What’s worse understand how the valuation and price moved quickly in a strange market, or at least under strange market conditions. We have war, inflation, supply chain issues and more.
So we’ll 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 T more context. In this article, we’ll look at why now might be the time to hoard T. The focus will be specifically on stable free cash flow yieldand maybe even growth.
Something weird happened
Let’s take a look at T vs. WBD, just for a minute.
I argued that T investors did not do well with their WBD. And, as I mentioned before:
…there was never a good time to sell T once we found out WBD was going their separate ways. If you were to sell immediately, you would be down since the price of T has already been suppressed by the market. And, if you held, your dividend was reduced and you got WBD. Since WBD went down, you lost money. In other words, your dividend income is down and your capital has eroded.
Also, I think that’s still true, if not more so than when I explained it in mid-May 2022. In short, T investors who also hold WBD should probably continue to hold WBD, rather than to sell. The assets of WBD are wonderful and in the long run it will probably 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) beaten the market
The most important point of this article is that T has maintained its price. The market neither rewarded nor punished T for the WBD spinoffs, at least in this short period. I think that’s good news, especially given this picture of the S&P 500 (SPY).
I see T as a beacon of sanity amidst a sea of chaos. Again, I’m only watching this from the WBD spin-off, to maintain clarity between our charts. Nevertheless, T barely moved as the market is down more than 16%.
What’s not entirely clear is why T is holding its price, while WBD and the broad market via SPY have fallen. My general view is that there is a shift to the physical world. I try to remember that while T is a technology company, it’s also a communications company with a huge physical footprint.
- Direct TV
This list goes on and on. Obviously, there are also a ton of services on top of this infrastructure. T is well positioned in the “real world” with his physical assets. Together we have a strong cash flow company, albeit with a heavy debt load. Yet their credit ratings are very good.
Now is the time to talk about T’s valuation issues over the past 5-10 years. It has to be seen in simple terms here, in terms of price.
AT&T has found the bottom
First, a quick shot, with a long view.
Some observations and notes include the following:
- T has been steadily declining for 10 years.
- T is no longer the same company as it was 10 years ago.
- The price of T fluctuates a bit over time.
But, that’s retrospective, and that’s just a view of the price of T. What about the value? What do we know? Well, as Morgan Stanley points out:
AT&T is steering free cash flow expansion into 2023 and beyond, both through adjusted EBITDA growth and reduced capital expenditures. EBITDA is expected to increase 6% in 2023, following 3% growth this year, and capital expenditures are expected to fall nearly 17% in 2024 to $20 billion, as deployment spending eases of 5G.
It is this growth in cash flow that also excites me for the future of T. It presents the company with enormous opportunities, from paying down debt, to increasing growth, to rewarding shareholders with growing dividends.
Ignoring WBD, again, we know that T surprises investors:
The company added 965,000 net postpaid subscribers and 691,000 net postpaid phone additions, beating expectations. On the wireline side, AT&T Fiber added 289,000 net subscribers, with penetration up about 2 percentage points to 37%.
And, T is trying to position itself for inflation, move the business forward faster, or at least maintain momentum with reasonable customers all around:
We went to a simplified pricing structure, I want everyone to understand what that means. We are not in the market at this time selling 12 month broadband promotional prices. We sell the customer a stable price for the duration of the relationship with us.
But I really want to come back to this, from T’s CFO, Pascal Desroches:
Now, let’s take a step back and look at the expected free cash flow generation from our business. As reported on our Analyst Day, we expect to generate approximately $20 billion of free cash flow in 2023. After paying dividends and minority interest commitments, we expect at least $10 billion in cash to remain. [Emphasis: Author]
Adding it all up, T grows in terms of subscribers and also free money. The company is also navigating through the pain of inflation and has room to keep pace, reasonably well.
As Bloomberg reports:
AT&T’s increases are the first for such plans in three years. The Dallas-based carrier is increasing monthly charges on those older plans up to $6 per month for single-line customers and up to $12 per month for families, a spokesperson confirmed Tuesday.
Anyway, by doing extremely rough calculations, we can get free cash flow per share, in 2023. We were told that T should generate $20 billion in free cash flow, and with about 7 .2 billion shares outstanding, we’re looking at around $2.80 in FCF per share in 2023. So, with T trading at around $20, we’re looking at a 14% FCF return in 2023. If we’re Conservatives, I think we’re probably looking at something like a Yield 11-12% FCF.
To check my common sense, I took a look at YCharts to see if my back-of-the-napkin calculations made sense. Well, here’s some good news:
What I see is that I’m definitely in the right ballpark, playing the right game. Also, and interestingly, T improves FCF yield for a long time. Like most investments, however, it’s a bit choppy. Nonetheless, seeing T with an FCF yield above 6% for so long is good news. And, expecting 14% by 2023 is also good news.
I have to make a few points to be fair all around. I’ve been hard on T at times, especially the management, because of how investors haven’t done well with WBD. As many of you guess, this will probably work out fine if you still own WBD after the spin-off. Time will tell us.
I was also hard on T because of how things went with the dividend. That is, my own dividend cash flow was compromised when T decided to spin off from WBD, and the dividend was cut. I had to “cure” this dividend, which was annoying, but the job is done. Composition is a beautiful thing, and T is just one item in my portfolio.
With all of this behind us, what I see is that You probably found a bottom. They now focus more on the core business. More importantly, I think, is that T works on macro issues. They also now deploy their rather large oligopolistic muscles. Few people can do what they do with pricing, whenever they want. I’m also excited about T’s strong FCF and FCF performance, in 2022, but also in 2023.
This big picture, and beyond WBD, gives me confidence in a Buy rating for T. My caution is that the markets are still in a mess and the price could go down, but probably not too crazy. Yet, it could happen. Thus, the conservative approach is likely to start a small position and an average dollar cost. Or, for longer-term investors, just the average cost in dollars. This is all to account for any real downside breakouts in the broader market.