Shares of telecom giant AT&T (T 1.02%) headed lower last Wednesday following a fourth-quarter report that was a bit less positive than investors may have been expecting. Overall, the company's results and guidance were solid. There were, however, a few issues that may have contributed to the post-earnings decline.
What went right for AT&T
When it came to revenue and free cash flow, AT&T knocked it out of the park. Revenue was up 2.2% year over year to $32 billion, ahead of the average analyst estimate by more than $500 million. Full-year free cash flow jumped to $16.8 billion, beating AT&T's updated guidance of $16.5 billion. The company started 2023 calling for free cash flow of at least $16 billion.
AT&T gained 526,000 net postpaid phone subscribers in the fourth quarter. While that tally was lower compared to the fourth quarter of 2022, the company gained more subscribers than in any other quarter of 2023. Postpaid phone churn remained remarkably low at 0.84%, and postpaid phone average revenue per user increased slightly.
Growth in the fiber business was steady, with 273,000 net adds more than compensating for subscriber losses in the legacy broadband business. Broadband average revenue per user was 8.8% higher year over year thanks to the shift toward pricier fiber services.
AT&T's outlook for 2024 was mostly positive. The company sees wireless service revenue rising by 3%, broadband revenue growing by at least 7%, and free cash flow between $17 billion and $18 billion.
Sticking points
There were two main issues with AT&T's report. First, while free cash flow is growing, earnings per share is declining. AT&T reported adjusted EPS of $0.54 in the fourth quarter, down from $0.61 in the prior-year period and just short of analyst expectations.
For 2024, the company's outlook calls for continued EPS declines. Adjusted EPS is expected to come in between $2.15 and $2.25, down from $2.47 in 2023. Multiple factors will drag down this profitability metric, including accelerated depreciation related to the company's network revamp, higher pension costs, lower interest income, and less equity income from its stake in DirecTV.
Second, AT&T's capital spending will decline in 2024, but not by all that much. The company expects capital investment, which includes capital expenditures as well as cash payments for vendor financing, to come in between $21 billion and $22 billion this year. That's down from $23.6 billion in 2023.
Lower capital spending, the result of AT&T getting past the peak of its 5G investment cycle, is expected to be a significant driver of free-cash-flow growth over the next few years. While AT&T expects solid free-cash-flow growth in 2024, investors may be concerned about the level of spending.
Still a no-brainer
The market wasn't thrilled with AT&T's fourth-quarter report, but it contained mostly positive news. Subscriber growth is still strong; free cash flow is on the rise; and both wireless and broadband revenue are set to grow in 2024.
Meanwhile, AT&T stock remains priced for disaster. With a market capitalization of around $119 billion, the midpoint of the company's guidance range puts the price-to-free-cash-flow ratio at 6.8. Based on the company's subdued adjusted EPS guidance, the stock trades for 7.5 times earnings. The company expects earnings growth to resume in 2025.
What makes AT&T an attractive investment, beyond the dividend (currently yielding over 6%), is the combination of free-cash-flow growth and the potential for multiple expansion. Even a modest improvement in valuation ratios, coupled with rising free cash flow, would lead to significant stock price appreciation.
Based on the market's reaction, though, AT&T still has some work left to do to convince investors that its stock deserves a loftier valuation.
