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Is Ma Bell a Good Buy in This Market?

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At the beginning of April, AT&T (NYSE: T) officially spun off its WarnerMedia business.

This spinoff came only a few years after the company fought tooth and nail to acquire Time Warner for $85 billion.

In completing the spinoff of WarnerMedia, AT&T has once again become a pure-play telecommunications business.

The company just released its first quarterly earnings report since the spinoff.

In the two days following the earnings release, AT&T shares dropped by 10%.

That said, there were a couple of big positive reveals in the company’s earnings report.

Revenue of $29.6 billion slightly beat consensus analyst estimates of $29.5 billion.

Plus, earnings per share of $0.65 beat consensus analyst estimates of $0.61 per share.

Yet, those results were overshadowed by what AT&T said is going to happen over the remainder of the year.

Specifically, it said that full-year free cash flow guidance for 2022 was being reduced from $16 billion to $14 billion.

Management explained that the $2 billion reduction is due to longer collection times for customers, higher costs for acquiring new subscribers and pressure on its business services unit.

As a result, shares dropped 10% following the earnings release.

Worth noting is that $10 billion of that $14 billion in free cash flow is expected to come during the second half of the year.

Management had previously indicated that full-year 2023 free cash flow would be $20 billion.

It therefore appears that management seems to think that free cash flow of $5 billion per quarter is a reasonable estimate moving forward.

Big Dividend and Disciplined Debt Reduction

Of the $20 billion free cash flow that this company expects to generate in 2023, a large chunk of it goes out to shareholders as dividends.

With 7.1 billion total shares outstanding and annual dividends (paid quarterly) of $1.11 per share, AT&T will be paying $7.9 billion per year in dividends.

That is easily covered by the $20 billion in free cash flow.

Looking ahead, AT&T’s dividend payout ratio, therefore, should be under 50%.

With the current share price of around $18, the $1.11 dividend equates to a sustainable 6.2% yield.

What happens to the excess free cash flow that isn’t paid out as dividends? It’s expected to wisely go toward debt repayment.

That means around the same amount of cash that is going toward dividends will go toward debt reduction.

In other words, shareholders will essentially be paid another 6.2% or more by means of debt reduction.

Combined, that kind of equates to a 12%-plus annual benefit for shareholders.

The cash that AT&T produces going forward will be put to good use – dividend payouts and debt reduction.

My biggest concern with AT&T, however, can be summed up in one chart.

Chart: Ma Bell Significantly Underperforms the Broader Market
This stock has significantly underperformed the broader market for many years.

There just isn’t much growth, and it is reflected in the share price.

Over the longer term, earnings growth is the main driver of share prices.

I like AT&T’s free cash flow. I like the dividend. I like the use of extra free cash flow to repay debt.

But without growth driving earnings and the stock, I can’t get more excited about AT&T than to say I think it is very slightly undervalued.

For someone looking just for income, there is some appeal here.

For long-term portfolio growth, there are better options elsewhere given the number of high-quality companies that have sold off this year.

Valuation Rating: Slightly Undervalued

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Good investing,

Jody

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