AT&T's (T -2.38%) stock price fell 8% following its second-quarter earnings report. The Dallas-based communications giant benefited from solid customer growth, but investors sold as its free cash flow fell considerably.
The fact that Verizon Communications (VZ -0.90%) and T-Mobile (TMUS -0.31%) are its only 5G competitors brings a high level of stability for customers. However, with this stability not extending to its stockholders, one has to question whether investors should own AT&T stock.
AT&T's continuing struggles
AT&T posted operating revenue of $29.6 billion. This figure rises 2.2% when one excludes the impact of its recently divested businesses. The company's operating income came in at an adjusted $5.9 billion, up 4% from $5.7 billion in the year-ago quarter when accounting for the divestitures.
Although the divestitures may have helped relieve pressure on AT&T, the divestitures did not solve all of its problems. Total debt is at $136 billion. While that improved from the nearly $176 billion in debt one year ago, it closely approximates the stockholders' equity, the company's value after subtracting liabilities from assets, of $137 billion.
Moreover, the second-quarter free cash flow of $1.4 billion probably led to the stock's sell-off. An additional $1.7 billion increase in capital investment reduced free cash flow. And the "timing of customer collections," an implication that fewer customers had paid their bills, decreased free cash flow by an additional $1 billion.
This situation may spook dividend investors who already suffered an end to AT&T's Dividend Aristocrat status and a reduction in the payout earlier this year. Dividend costs for the quarter came in at $2.1 billion. This figure helps support a $1.11-per-share annual dividend yielding around 5.8%, well above the S&P 500 average of 1.6%.
AT&T still offers some bright spots
Nonetheless, while the free cash flow issues seem concerning, the investment case for AT&T may not have worsened. To be sure, the company made costly mistakes by buying DirecTV and Time Warner. But now that it has divested these assets, it can devote more of its capital to improving its network, a necessity when Verizon and T-Mobile also primarily focus on their networks.
Also, the lower cash flow looks like a temporary problem. On the Q2 2022 earnings call, CFO Pascal Desroches said lower device payments and capital expenditures would allow free cash flow to rise to $10 billion for the second half of the year, more than double the $4.2 billion in the first half. Such cash flows should support the dividend on a longer-term basis.
Moreover, the company continues to attract new customers. AT&T reported 813,000 net additions for the second quarter, the best quarterly performance in more than 10 years. The AT&T Fiber segment reported 316,000 net adds for its consumer wireline business. This performance serves as a bright spot for the telco that continues to have the largest market share.
Investors should also remember that AT&T is only one of three 5G providers in the U.S. market. The company spent $9.5 billion in capital expenditures in the first six months of 2022 alone to help maintain its businesses. With peers Verizon and T-Mobile also having to spend heavily on capex, additional competitors are unlikely to enter its market.
Should I consider AT&T stock?
AT&T looks like a buy, but only for more risk-tolerant income investors. The telecom stock claims a significant market share and is growing customer numbers in a business with a prohibitively high barrier to entry. It also pays a higher-than-average dividend, whose long-term cash flows can support the payout. Hence, it could make sense for a small portion of an income portfolio.
Still, with the Dividend Aristocrat status gone, AT&T will face fewer consequences if it slashes the payout again to cover its expenses. This factor is likely to lead to diminished interest from income investors.
Also, AT&T must continue to invest heavily in capex and remains heavily indebted even after the divestitures. Such financial worries will probably remain a growth headwind for some time to come, even if it maintains the payout.