Why AT&T Dropped 10.4% in July

What happened

Shares of AT&T (T 0.27%) fell 10.4% in July, according to data from S&P Global Market Intelligence. The telecommunications giant reported earnings that were better than analysts expected but gave a bleak forecast for free cash flow generation in 2022. Despite the S&P 500 rising 9.1% in July, AT&T's stock sank as a result.

So what

AT&T released its second-quarter earnings on July 21. Revenue was $29.64 billion in the period, down from $35.7 billion a year ago but up 2%, excluding the impact of divested subsidiaries. Adjusted earnings per share (EPS) came in at $0.65, above the $0.61 management expected. AT&T is seeing solid growth from both its mobile phone business (about 800 thousand net adds in the quarter) and fiber communications business (about 300 thousand adds in the period). So what caused the stock to drop so much?

The lowlight from the report was management's guidance for cash flow generation this year. Higher capital expenditures needed for building 5G infrastructure and customers delaying payments due to a softening economy caused AT&T to drop its full-year free cash flow guidance from $16 billion to $14 billion. Seeing as free cash flow is the true measure of profitability for a business and that AT&T will need a healthy dose of it to pay down all its debt, it is no surprise investors reacted negatively to this news.

Now what

AT&T investors are nervous about the company's cash flow forecasts because of how much debt is on its balance sheet. At the end of Q2, it had $131.9 billion in net debt, which is over nine times its free cash flow projections for 2022. This likely won't be detrimental to the business because of how evenly spread the debt repayments are over the next few decades and because of the likelihood it will be able to refinance and roll over with new bond offerings when each debt repayment comes due. However, with rising interest rates and a tightening economy, this will become increasingly costly for AT&T to do.

Many people also invest in AT&T because of its high dividend, which currently has a yield of 5.93% per share. The company maintains this high dividend because of all the cash flow that it generates. If cash flow deteriorates further, the company will be forced to cut its dividend, which will not make shareholders happy.

There are plenty of other stocks to invest in. Unless you invest in AT&T solely for the dividends, it is probably best to avoid buying shares right now.