AT&T's (T 1.02%) stock rallied nearly 7% on Oct. 19 after the telecom giant posted its third-quarter earnings report. Its revenue rose 1% year over year to $30.35 billion and surpassed analysts' estimates by $110 million. Its adjusted EPS dipped 6% to $0.64, but still cleared the consensus forecast by two cents.
AT&T's growth rates might seem unimpressive, but its business is finally stabilizing following its spin-offs of DirecTV and Warner Bros. Discovery. Those divestments, which closed over the past two years, enabled AT&T to strengthen its core telecom business and return more of its cash to its investors.
Image source: AT&T.
But even after its post-earnings pop, AT&T's stock remains down about 17% this year. It looks dirt cheap at 6 times forward earnings, and it pays a high forward yield of 7.8%. But will it bounce back over the next 12 months?
Its wireless business continues to expand
AT&T's mobility business added 2.9 million postpaid phone subscribers in 2022. It added another 424,000 postpaid phone subscribers in the first quarter of 2023, which marked its 12th consecutive quarter of at least 400,000 postpaid phone net adds.
That streak ended in the second quarter when it only added 326,000 postpaid phone subscribers and broadly missed analysts' expectations for at least 400,000 net adds. That big miss was one of the main reasons AT&T's stock stumbled over the past year.
But in the third quarter, AT&T added 468,000 postpaid phone subscribers and exceeded the consensus forecast for 430,000 net adds. Its churn rate among those customers also improved year over year from 0.84% to 0.79%. As a result, AT&T's total mobility revenue rose 2% year over year to $20.7 billion.
During the conference call, CFO Pascal Desroches attributed those gains to the company's subscriber growth and rising average revenue per user (ARPU) for its legacy wireless plans. The segment's earnings before interest, taxes, depreciation, and amortization (EBITDA) margin also expanded year over year -- which indicates its ongoing pricing war against Verizon Communications and T-Mobile isn't crushing its margins.
Its wireline business is still a mixed bag
AT&T's consumer wireline business continues to grow as it expands its fiber networks, but the ongoing decline of its business wireline business is still offsetting a lot of those gains.
Its consumer wireline revenue rose 5% year over year to $3.3 billion in the third quarter. That growth was mainly driven by its fiber network, which gained 296,000 net adds and offset the slower growth of its non-fiber businesses. That represented the fiber segment's 15th consecutive quarter of more than 200,000 net adds. The segment's EBITDA margin also rose year over year as it pivoted toward those pricier plans.
Unfortunately, its business wireline revenue declined 8% year over year to $5.2 billion as its EBITDA margin contracted. This business has been struggling with the sluggish demand for legacy voice and data services across the enterprise market.
Lastly, investors should remember that AT&T's wireline business still faces a lot of unanswered questions regarding the lead-sheathed copper cables in its legacy networks. If AT&T is forced to remove and replace all of those cables, its wireline margins could be crushed.
But it raised its free cash flow guidance
Prior to spinning off WBD last year, AT&T claimed it could generate $20 billion in free cash flow (FCF) as a stand-alone company in 2023. But as the macro environment deteriorated, it reduced that outlook to $16 billion.
When AT&T only generated $1 billion in FCF in the first quarter of 2023, the alarm bells went off and the bears claimed it would need to reduce its FCF guidance again. The bears also warned that AT&T would likely need to slash its massive dividend -- which consumed $10 billion of its FCF in 2022 -- to burn less cash.
But in the second quarter, AT&T generated $4.2 billion in FCF and reiterated its goal of generating $16 billion in FCF for the full year. In the third quarter, it generated another $5.2 billion in FCF, which boosted its year-to-date FCF to $10.4 billion. It also raised its full-year FCF guidance to $16.5 billion, so its dividends are still well-funded.
AT&T also continues to chip away at the mountain of debt it accumulated through its acquisitions of DirecTV, Time Warner, and spectrum licenses. It reduced its net debt by $3 billion during the third quarter and reiterated its long-term goal of reducing its net debt to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio to 3 by the end of 2023 and 2.5 by the first half of 2025.
Where will AT&T's stock be in a year?
AT&T's low valuation and high yield should limit its downside potential, but high interest rates will also cap its near-term gains as long as CDs and Treasury bills pay 5%-6% yields. Therefore, I believe AT&T's stock will hold steady, but still underperform the market over the next 12 months.
