Despite a substantial subscriber base and extensive operations, AT&T Inc. (T, Financial) experienced a 10% decline in its share price in 2023. This downturn contrasts sharply with the S&P 500's gain of 24% over the same period.
Let's delve deeper to see whether AT&T is a good choice for investors now. In this analysis, I will explore the company's financial performance, debt burden, dividend history and current valuation to provide a comprehensive overview of its investment potential.
Business description
The telecommunications and technology service leader serves around 217 million subscribers and operates under two primary segments: Communications and Latin America. In 2022, the Communications segment was the largest contributor to revenue, generating $117.1 billion, which constituted 97% of AT&T's total revenue. In contrast, the Latin America – Mexico segment contributed $3.1 billion, or 2.6% of total sales. Segmented by the class of services, Wireless Services are the largest revenue generator within the Communications segment, accounting for 50% of the segment's total revenue. In comparison, Business Services and Equipment each represented 18% of 2022 sales.
Third-quarter revenue rises, but income falls
In the third quarter of 2023, AT&T reported revenue of $30.4 billion, a 1% increase compared to the same period a year prior. This growth is partly attributed to the company's expanding customer base, which has doubled to over 8 million subscribers in less than four years. Notably, the number of postpaid phone subscribers rose from 69 million in the third quarter of 2022 to 70.8 million. Alongside this growth, the average revenue per user increased slightly from $55.67 to $55.99.
Despite these positive trends in revenue and subscriber numbers, AT&T's operating income experienced a decline of 3.8%, falling to $5.78 billion. This decrease was primarily due to higher non-cash charges, including asset impairments, abandonments, restructuring, depreciation and amortization. However, it's important to note the company's cash flow from operating activities showed improvement, rising from $25.46 billion in the previous year to $26.94 billion in 2023.
Stable cash flow generation and infrastructure expansion
A notable strength of AT&T is its consistent generation of positive operating and free cash flows over the years. Since 2012, the company's operating cash flow has fluctuated between $31.3 billion and $48.67 billion, while its free cash flow has remained in the range of $10.14 billion to $29 billion. In 2012, the company's free cash flow was approximately $12.4 billion. It is projected to grow to $16.5 billion for 2023.
Further, AT&T boasts a leading position in broadband infrastructure in America. Its mid-band 5G spectrum currently covers 190 million people, with plans to expand coverage to 200 million by the end of 2023. The company also operates the largest consumer fiber network in the country, serving 20.7 million consumers and 3.3 million business locations. By the end of 2025, AT&T aims to expand its fiber network to over 30 million locations. This robust infrastructure with economies of scale provides a solid foundation for the company to maintain consistent cash flow in the coming years.
High debt burden, but decent interest coverage
Investors are concerned about the company's substantial debt burden. As of September, AT&T reported $117.86 billion in shareholder equity, yet its cash and cash equivalents amounted to just $7.54 billion. The interest-bearing debt stood at $138 billion, with operating lease liabilities and post-employment benefits totaling an additional $24.23 billion. However, this long-term debt is spread out over several years. In the next one to three years, the company faces long-term debt obligations and interest payments of approximately $24.8 billion.
Source: AT&T 10-K filing
Given its average annual operating cash flow of $38.8 billion over the past decade, I believe AT&T is well positioned to meet its debt and interest obligations. The company's consistent performance demonstrates its financial resilience. Although the debt-to-interest ratio has risen from 0.76 in 2012 to 1.59 in 2022, the interest coverage ratio has always remained at a minimum of 3.19. In 2022, this ratio increased to 3.75.
Unsustainability of historical dividend growth
Income investors might find AT&T appealing due to its history of consistent dividend payments. The company's dividend per share steadily increased from $1.77 in 2012 to $2.08 in 2021. However, there was a significant drop of 46.6% to $1.10 per share afterward. Although the dividend payments from 2012 to 2021 experienced consistent increases, the dividends were not consistently proportionate to earnings. The dividend payout ratio varied significantly, ranging from 0.39 to 1.78. Notably, in four of the past 10 years, the payout ratio equaled or exceeded 1, indicating the company paid out dividends equal to or more than its earnings for those years. This suggests the previous trend of consistent dividend increases would not sustainable in the long term.
Fairly valued
Applying the 10-year average free cash flow multiple of 16 to the expected free cash flow of $16.5 billion, AT&T's enterprise value comes in at around $264 billion. After adjusting the current net debt of nearly $160 billion, the stock's intrinsic value should be around $14.55 per share. This value is just 13% lower than the current share price of $16.80, suggesting AT&T's stock is trading at a fair value.
Additionally, let's use the discounted free cash flow model to estimate AT&T's intrinsic value. Let's assume that for the next five years, its free cash flow grows at a rate of only 3% per year, followed by a terminal growth rate of 1% per year in the subsequent 10 years. Given the significant volatility in the free cash flow generation, a high discount rate of 15% can be applied to this calculation. With those assumptions, AT&T's estimated value per share would be close to $18, only 8% higher than the current price. This further supports that AT&T is currently fairly valued.
Conclusion
AT&T, despite its solid foundation in the telecommunications industry, faces a complex financial landscape marked by a significant debt burden and declining share price performance. While the company has strong revenue generation, a widespread network infrastructure and a growing subscriber base, these positives are offset by concerns over its high debt, the recent drastic reduction in dividend payouts and the ability to maintain sustainable dividend growth. My calculated valuation indicates AT&T's stock is currently fairly valued. I would rather wait for an undervalued price before initiating a long position.
