AT&T's (T -1.54%) stock price tumbled 8% on July 21 after it posted its second-quarter earnings report. On a stand-alone basis -- which excludes its divestments of Warner Bros. Discovery (WBD 0.09%), DirecTV, and other business segments over the past year -- its revenue rose 2% year over year to $29.6 billion and exceeded analysts' expectations by $130 million.
On the same stand-alone basis, AT&T's adjusted earnings from continuing operations rose by a penny year over year to $0.65 per share, which also cleared Wall Street's bar by three cents. Those headline numbers looked stable, but a few thorny details in the earnings report spooked the bulls.
Let's dig deeper and see how the bears and bulls likely viewed AT&T's latest earnings report, and if its post-earnings sell-off represents a warning or a buying opportunity.
What the bears saw in AT&T's report
The bears will point out that AT&T's margins contracted as it reduced its free cash flow (FCF) forecast for the full year. Its operating margin fell 50 basis points year over year to 31.2%, while its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin declined 110 basis points to 41.3%. The compression was caused by the ongoing expansion of the mobility's segment's 5G networks, as well as higher costs at its business wireline division.
That elevated spending wasn't surprising, since AT&T had spun off WarnerMedia, DirecTV, and its other smaller media business segments to focus on strengthening its core telecom business to compete more effectively against Verizon Communications (VZ -0.92%) and T-Mobile (TMUS -1.46%).
But during its analyst day presentation in March, AT&T told investors it could generate $16 billion in FCF for the full year. It reiterated that target during its first-quarter conference call in April.
But this time, AT&T abruptly reduced its full-year FCF forecast to $14 billion. It attributed that reduction to higher-than-expected capex, higher investments in its subscriber growth, a $1 billion impact from delayed customer collections, and tighter operating margins at its business wireline division.
AT&T can still easily cover its planned dividend payments of about $8 billion with its lower FCF. However, there's likely a lingering fear that AT&T might cut that guidance again if the macro situation worsens.
AT&T reduced its net debt by about $37 billion during the quarter, but it's still burdened with a high net debt to adjusted EBITDA ratio of 3.2. That's still well above the target ratio of 2.5 that it plans to reach by the end of 2023.
What the bulls saw in AT&T's report
Yet there were still plenty of reasons to like AT&T's report. Its mobility segment gained 813,000 postpaid phone net adds during the quarter, which represented its strongest second quarter in over a decade. The mobility segment's average revenue per user also increased both sequentially and year-over-year.
As a result, AT&T boosted the full-year revenue forecast for its wireless service revenue -- which accounted for 51% of the company's top line in the second quarter -- from "3% or better" to 4.5%-5%. As for its broadband business, AT&T Fiber gained 316,000 net adds during the quarter, representing the segment's tenth consecutive quarter of more than 200,000 net adds. It also reiterated its full-year guidance for more than 6% growth in broadband revenues.
The rest of AT&T's guidance remained unchanged. For the full year, it still expects its revenue to rise by the low single digits, and for its adjusted EPS to increase 0%-2%. It maintained its full-year capex target of $24 billion, which will be mostly spent on upgrading its 5G and fiber networks, as well as its target of $4 billion to $6 billion in transformation-related savings.
Which thesis makes more sense?
AT&T looks like a much more promising investment after its recent divestments of WBD and DirecTV. Its low forward price-to-earnings ratio of eight and its high forward dividend yield of 5.3% should also limit its downside potential in this value-oriented market.
Its declining margins and FCF are worrisome, but it's also encouraging to see AT&T ramp up its investments in its core telecom businesses again instead of building a loss-leading media empire. Its full-year guidance also suggests it will stabilize its business and become more similar to Verizon, which trades at nine times forward earnings and pays a slightly lower forward yield of 5.1%, over the long run.
Therefore, AT&T is still a good value play for a bear market or a recession. It won't generate explosive gains, but it should be a safe place to park your cash as macro headwinds rattle the broader markets.