Last April, AT&T (T 1.02%) spun off WarnerMedia and merged it with Discovery to create new-media giant Warner Bros. Discovery (WBD -2.17%). That spinoff, along with its divestment of DirecTV in August 2021, finally ended the telecom giant's ill-conceived plans to become a pay-TV and media superpower.
When the spinoff concluded on April 8, AT&T's investors received 0.241917 shares of WBD for each share of AT&T they held. That split represented a fresh start for AT&T, but if you had invested $1,000 on April 11, the first day it started trading independently of WBD, your investment would only be worth $685 today. Even after factoring in a year of dividends, your investment would be worth only $750. The same investment in an S&P 500 index fund would still be worth just over $1,000.
Image source: AT&T.
What happened to the "new" AT&T?
After AT&T spun off DirecTV, WarnerMedia, and its other noncore media assets, it committed itself to expanding its 5G and fiber businesses. But to account for its distribution of WBD to its investors, AT&T nearly halved its annual dividend in early 2022. It had already broken its 36-year streak of annual dividend increases in 2021.
That dividend cut wasn't surprising, but it probably disappointed many investors who had held AT&T -- and its predecessor, SBC -- as a long-term income investment for nearly four decades. It also preceded a rapid increase in interest rates, which drove many investors from blue chip dividend stocks toward fixed-income investments with lower risk and comparable yields.
The new AT&T continued to expand its wireless business at an impressive rate. It added nearly 2.9 million postpaid phone subscribers in 2022, and then gained 424,000 subscribers in the first quarter of 2023. Rival Verizon (VZ 1.17%) gained only 201,000 postpaid phone subscribers in 2022 and actually lost 127,000 subscribers in the first quarter of 2023.
Unfortunately, the declining revenue from AT&T's business wireline division -- which has been grappling with the waning usage of landlines for voice calls and macro headwinds for broadband upgrades -- is offsetting a large portion of its wireless gains. It's expanding its consumer-facing fiber networks to counter those headwinds, but its total number of broadband customers -- business and consumer -- has still been shrinking.
AT&T's revenue still rose 2% on a standalone basis from continuing operations to $118.2 billion in 2022, but cutthroat competition in the wireless market, higher spending on 5G and fiber upgrades, and elevated business wireline expenses have all been compressing its margins. It still generated $14.1 billion in free cash flow (FCF) for the full year, which easily covered its $9.9 billion in dividends, but its adjusted EPS dipped 2%.
Why aren't the bulls rushing back?
For 2023, analysts expect AT&T's revenue to rise only 1% as its adjusted EPS drops another 8%. That outlook suggests the macro and competitive headwinds won't dissipate anytime soon -- but its stock looks dirt cheap at six times forward earnings and pays a high forward dividend yield of 7.7%. By comparison, Verizon trades at seven times forward earnings and also pays a forward yield of 7.7%.
That low valuation and high yield look tempting, but the bulls aren't biting because AT&T generated only $1 billion in FCF in the first quarter of 2023. That's a bad look for a company that aims to generate $16 billion in FCF and pay out roughly $10 billion in dividends this year. AT&T says its big investments in 5G and fiber, along with seasonal headwinds, reduced its FCF during the quarter -- but it claims those costs had peaked and could decline throughout the rest of the year.
However, many investors are skeptical of that rosy outlook because AT&T had already reduced its FCF forecast for 2023 from $20 billion to $16 billion last year. Another disappointing reduction could endanger its dividend -- which makes it a lot riskier than most fixed-income investments even though it technically sports a higher yield. Those fears only got worse recently, when reports surfaced that AT&T and other telecom providers might have liability from wireline assets containing potentially hazardous lead-based materials.
AT&T was also still shouldering $134.7 billion in net debt at the end of the first quarter, which, in terms of net debt to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), gives it a high ratio of 3.2. It wants to reduce that ratio to 2.5 by early 2025, but doing so could be challenging if its FCF dries up. If that happens, it would make more sense for AT&T to cut or eliminate its dividend to reduce its debt. A lot of those fears already seemed priced into its valuations.
Should you stick with AT&T?
If you already own AT&T, you should probably stick with it and see if its FCF growth accelerates again and provides better support for its dividends and debt reduction plans. If that happens, the bulls could finally come back. But if you don't own AT&T, it might be smarter to simply stick with fixed-income investments or more promising blue chip dividend stocks than betting on this telecom giant's sluggish turnaround.
