AT&T (NYSE:T) offers a high dividend yield that is sustainable due to good earnings and cash flow coverage, plus its shares trade at an undemanding valuation, making it a good choice for income-oriented investors.
However, since mine previous articleAT&T’s stock price has been relatively weak due to the cable issues, so in this article I analyze AT&T’s recent financial performance and update its investment case to see if it remains a good income play. or not.
Financials and recent dividends
In terms of its most recent financial performance, AT&T reported about a month ago its third-quarter earnings, which were above estimates for both revenue and bottom line, as shown in the following chart, was the best quarter compared to expectations during the previous year. and led to a positive stock price reaction during the day.
Her income in Q3 reached $30.4 billion, up 1% year-on-year, driven by subscriber growth due to the company’s 5G and fiber deployments that are making it more competitive in the market. In the third quarter, AT&T was able to add about 468,000 additional customers on a net basis, which is quite a positive result given the stiff competition from T-Mobile USA (TMUS) and Verizon (VZ).
Indeed, since the US telecom industry is largely mature, customer acquisition has largely come at the expense of market share growth, making it quite difficult for the three biggest players to win customers on a recurring basis. from quarter to quarter.
In recent years, T-Mobile US has delivered the highest customer growth in the wireless segment due to strong investments in 5G deployment and several other benefits for new subscribers, while AT&T also reported positive numbers, while Verizon has been the main loser. As shown in the following chart, AT&T is the market leader with a market share of nearly 47%, followed by Verizon and T-Mobile.
While there is a fourth operator, US mobile Corp (USM), the market may eventually concentrate on three operators, taking this into account Telephone and data systems (TDS) has put its stake in US Cellular under strategic review a few months ago, and a possible sale could happen in the near future, as I analyzed recently.
Given that US Cellular has a very low market share of less than 1% in the wireless segment, it is likely that an eventual sale to a larger competitor will be approved by regulators, which will be positive for established players reducing competition.
On the other hand, if US Cellular is eventually sold to a foreign telecommunications company that could use this acquisition to enter the US market, this could be a negative factor for the larger players as a new competitor would most likely be competitive in service offerings, especially on prices, which could lead to pressure on prices for the three largest operators.
While nothing is confirmed at this stage and an eventual transaction may not happen, this is a risk that telecom investors should be aware of and should not overlook.
In the third quarter, AT&T was able to increase its average revenue per user (ARPU) and reported low levels of customer churn, which is a very positive sign of its good competitive position in the industry and makes me less concerned about potentially more competition in the industry. the future. Due to this positive backdrop, its mobility service revenue grew by 3.7% YoY last quarter to $15.9 billion and its EBITDA margin improved by 200 basis points compared to the same quarter last year. .
Beyond the positive operating metrics in the mobility segment, AT&T also reported positive numbers related to its broadband segment. In the third quarter, it added 296,000 net new fiber customers, being a key growth driver for revenue in this business unit.
Indeed, its consumer broadband revenue rose 9.8% year-over-year, of which fiber revenue rose 26.9% year-over-year to $1.6 billion in the latest quarter. While fiber is still relatively small within the group, its growth path is quite good, having doubled its customer base in less than four years to more than 8 million subscribers in the last quarter. That means AT&T appears to be on track to achieve more balanced fiber and fixed-wireless revenue in its broadband business, which is key to offsetting the structural decline in its broadband operations. legacy cable line.
Indeed, its commercial cable business continues to be its main weak spot, reporting lower revenue in the latest quarter, a trend that is likely to continue in the short term and should continue to be a drag on AT&T’s core growth over the next few years.
As for its expenses, AT&T’s operating expenses were $24.6 billion in the third quarter, up 2.5% year over year, a higher growth rate than revenue. This means its operating margin fell compared to the same quarter last year, as inflationary pressures are leading to higher costs, despite the company’s restructuring efforts and measures to improve efficiency in recent quarters. Its operating income fell to $5.8 billion, down 3.3% year-on-year, representing an operating margin of 19.1%.
For the full year, AT&T raised its guidance, expecting adjusted EBITDA growth of 4%, up from 3% previously, and also raised its free cash flow guidance to $16.5 billion.
This was well received by the market, as it shows management’s confidence in the business’s outlook during a challenging economic period, and is positive for its dividend.
After cutting the dividend last year, the company now offers a stable dividend, although it has been unchanged since May 2022. Its current quarter dividend is $0.2775 per share, or $1.11 per year, which at the current share price leads to a dividend yield of close to 7%.
While in some cases a high dividend yield can be a warning sign of poor dividend sustainability, this is not the case for AT&T, given that its dividend is well covered by both earnings and cash flow.
Indeed, its dividend payout ratio relative to 2023 earnings is expected to be just 49%, based on the current EPS estimate of $2.25, which is a very conservative payout ratio for a mature company like AT&T. Additionally, its annual dividend payout is around $8 billion, while free cash flow generation is expected to be around $16.5 billion, so AT&T generates plenty of cash to maintain its dividend and eventually grow it. over the next few years.
However, I don’t expect a growing dividend in the next twelve to eighteen months because AT&T also wants to reduce its balance sheet leverage and is using a good portion of its free cash flow to reduce debt. At the end of Q3 2023, its net debt stood at $128.7 billion, a reduction of more than $3 billion since the beginning of the year, and AT&T is targeting a net debt-to-adjusted EBITDA ratio of about 2.5x (vs. 2.98 x expected in 2023), to be reached in the first half of 2025.
While AT&T may decide to start giving a dividend increase in the coming quarters, I think it’s more likely that meaningful dividend growth won’t start until 2025, when AT&T is expected to reach its desired leverage ratio. Street seems to agree with this view as, according to analysts’ estimates, its dividend is not expected to increase much in the coming quarters as the 2025 dividend is expected to be $1.12 per share, virtually unchanged compared to the dividend actual.
Regarding lead cable issues, this is a potential risk that investors should not overlook as the potential costs are quite significant. Responding to a Wall Street Journal REPORT that telecom companies may need to remediate thousands of lead-insulated cables that can leach the toxic metal into the environment, AT&T said only about 10% of its copper cables may be exposed to the problem, which could eventually ‘cost the company some $10 billion to fix according to some estimates.
While the exact cost to fix this problem is impossible to know, it appears to be a manageable issue that is unlikely to hurt the company’s dividend. Indeed, in 2023, the dividend payout based on free cash flow is expected to be around 50%, so there is plenty of room to maintain its dividend and still have the financial resources to address cable issues. main. Moreover, this problem is likely to be solved in the long run upcoming yearsso its cost will most likely be spread over time and doesn’t appear to be a major threat to AT&T’s current annual dividend.
AT&T has reported improved operating metrics in recent quarters. and its near-term business prospects appear to be positive due to its growth strategy in mobile and fiber, which is bearing fruit through net customer additions and price gains.
Despite this, its stock continues to trade at a relatively undemanding valuation, given that AT&T is currently COMMERCIAL at just 6.4 times forward earnings, a discount to its historical average over the past five years. Furthermore, the dividend yield of close to 7% is an excellent play for income-oriented investors, as the dividend is clearly sustainable in the short to medium term, even taking into account potential risks such as major cable issues .