Share prices of AT&T (T 3.40%) fell in Thursday trading following its earnings release for the first quarter of 2023. Although the telecom giant increased its subscriber base, the results showed growth decelerating. The report also highlights some further uncertainties for the telecom stock, so investors might have to adjust their expectations.
AT&T's first-quarter earnings
In the first quarter of 2023, operating revenue came in at $30.1 billion, rising 1% from the same quarter last year. A 3% gain in service revenue, which accounts for 82% of company revenue, offset a 3% reduction in equipment sales.
Net income of just under $4.5 billion dropped by 14% year over year. AT&T's operational performance improved, with operating income rising by 8%. Still, a 57% drop in other income (meaning income from investments) resulted in falling profits.
The decline carried over to free cash flow. In addition to the lower net income, AT&T received less cash from DirecTV distributions and spent more heavily on vendor financing. This reduced its free cash flow to just $1 billion, well under the $2.8 billion in the year-ago quarter.
While factors such as an increase in accounts payable indicate the lower cash flow is temporary, free cash flow lagged the quarterly dividend payments of $2 billion, meaning it drew on its cash reserves to cover the dividend cost. Over the last three months, AT&T's cash position fell by about $900 million to $2.8 billion.
This is bad news for income investors, who suffered the first dividend cut in decades last year. Without a multi-decade streak of payout hikes to bolster confidence, income investors face the possibility of another dividend reduction.
The state of AT&T stock after earnings
Despite a rock-bottom price-to-earnings (P/E) ratio of 7, a low earnings multiple has failed to protect the stock from disappointing reports. AT&T shares dropped by 10% in the trading session following the report.
A moderation in demand appears to have hit the stock. Although AT&T reported 424,000 net additions of postpaid subscribers during the first quarter, that lags the year-ago quarter when postpaid net additions came in at 691,000.
Moreover, as the transition to 5G continues, the company remains locked in a battle for subscribers with its two major competitors, Verizon and T-Mobile. Neither company had released its first-quarter earnings at the time of this writing. Still, they are the only three companies that provide nationwide 5G service in the U.S. Given the massive cost of building a nationwide 5G network, the emergence of other competitors is unlikely.
But T-Mobile has gained market share by offering lower pricing and by buying out Sprint. T-Mobile's stock also outperformed Verizon and AT&T. It holds the advantage of lower legacy costs and is the only one of the three not to pay a dividend. That should concern AT&T's income investors as network buildouts and maintenance claim massive amounts of capital.
Making sense of the stock
Amid the current conditions, investors should probably refrain from adding shares. Despite positive net additions, growth remains a struggle. Moreover, falling free cash flow and the competition pose further danger to a dividend that is trending downward after decades of increases.
The low P/E means you can buy AT&T stock on the cheap, and likely with limited downside. Nonetheless, until the telecom can improve revenue growth and free cash flow, you should probably stay on the sidelines.
