Consumers have virtually no shortage when it comes to telecommunications providers. Whether it's Verizon, T-Mobile, or AT&T (T 1.02%), people are barraged with a recurring carousel of commercials filled with celebrities and catchy jingles. These marketing tactics can make it challenging to discern one company's product offerings over another. Luckily, investors are privy to the underlying trends of these operations and get a glimpse into the performance of the business during earnings season.
AT&T is gaining momentum across 5G mobility and fiber infrastructure, helping the company reduce net debt and increase free cash flow. In turn, the company's management remains committed to rewarding shareholders with its generous dividend.
Despite this progress, AT&T stock has been no stranger to gloomy investor sentiment for the last several years. In fact, the stock is trading near its lowest level in nearly three decades. While this doesn't look like a great picture, I think there are several reasons to believe that AT&T stock is worth a second chance. Let's dig in.
Higher value customers
For the quarter ended Sept. 30, AT&T reported revenue of $30.4 billion, up only 1% year over year. The table below illustrates the company's growth profiles across the mobility and wireline business.
| Metric | Mobility | Wireline |
|---|---|---|
| Q3 revenue % growth year over year | 2% | (4%) |
| Q3 adjusted EBITDA % growth year over year | 7.6% | (7%) |
Data source: Q3 investor presentation.
Investors can see that while revenue in the mobility business only grew by 2% in Q3, adjusted EBITDA increased significantly. Management attributed the growth to increases in wireless services and higher average revenue per user (ARPU). Moreover, churn in AT&T's postpaid phone division has improved significantly from last year, signaling lower customer turnover rates.
When it comes to the wireline segment, there is more than meets the eye. AT&T actually increased revenue in consumer wireline products driven by higher ARPU compared to last year. However, the company's business wireline division remains "in transition" as AT&T replaces legacy connectivity solutions with newer product offerings. For this reason, investors should expect more muted growth in that business.
Given the higher ARPU across multiple areas of its business, AT&T has enjoyed widening product margins, which is helping fuel a rising free-cash-flow profile. This is an important dynamic as it pertains to long-term debt levels and AT&T's liquidity position.
Image source: Getty Images.
Cash flow is king
From my stance, the most important nugget from AT&T's earnings report is the company's cash flow. Like many telecommunications businesses, AT&T carries a significant chunk of debt on its balance sheet. If the company is not growing and generating increasing profit, then the operation can quickly become overleveraged as debt payments loom. The table below illustrates AT&T's free cash flow and debt ratio over the past year.
| Item | Q3 2022 | Q4 2022 | Q1 2023 | Q2 2023 | Q3 2023 |
|---|---|---|---|---|---|
| Free cash flow | $3,840 | $6,103 | $1,004 | $4,209 | $5,182 |
| Debt ratio | 48.8% | 56.1% | 55.9% | 54.8% | 53.5% |
Data source: Q3 investor presentation. Dollar figures in billions.
Investors can see that over the past year AT&T has generated billions of dollars in free cash flow. In turn, the company has been able to use its cash flow to continue paying down debt as well as reward shareholders with a dividend. Although the company's debt ratio is higher now than it was a year ago, AT&T has gradually improved this metric during 2023.
Additionally, during the Q3 earnings call, management raised its free-cash-flow forecast by $500 million to $16.5 billion for the year. This is a positive sign as it signals strong momentum going into the end of the year and management's confidence that it will be able to continue paying down debt and "deliver additional shareholder returns."
Should you invest in AT&T?
When it comes to share valuation, I am going to focus on AT&T's forward price-to-earnings (P/E) multiple and its price-to-free cash flow.
Data source: YCharts
The charts above show that AT&T stock trades at a P/E and price-to-free cash flow of just 6.1, both well below levels earlier this year. As I outlined above, the company's revenue growth is far from that of a growth stock. However, AT&T's expanding margins across core areas of the business have helped fuel some much-needed debt relief. Moreover, the excess free cash flow has been used to continue paying a nice dividend, currently yielding over 7%.
A contrarian investment strategy could be to take advantage of the depressed price to lower your cost basis, assuming you're an existing shareholder. While AT&T still has a lot to prove, the stock looks tempting at its current levels. I would argue that the business is moving in the right direction as it seeks to reinvent itself in an age of otherwise commoditized product offerings.
I think now is a great opportunity to dollar-cost average into the stock. However, I would urge investors to keep an eye on free cash flow and debt levels in future quarters to ensure the long-term thesis is upheld.
