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The AT&T (NYSE:NYSE:T) stock has traded down to almost its all-time low based on valuation multiples as it reels from both the broad-based market selloff, as well as shaky investors’ confidence in the outlook of the company’s strategic transformation following its exit from media and entertainment earlier this year. Despite management’s decision to slash its free cash flow guidance for the year from previous projections of $16 billion to now $14 billion, citing operational uncertainties under record-high inflationary pressures on its core end-markets, AT&T’s share gains across wireless communications and fiber – its two primary growth engines – remain robust. The company reported more than 800,000 net adds in its mobility business during the second quarter despite early-year price hikes, beating key rivals T-Mobile (TMUS) and Verizon (VZ) in the face of heated competition. Fiber take-rates also remained strong, with net adds exceeding 300,000 in the three months through June.
Despite earlier observations of lengthening consumer payment collection cycles and related bad debt expenses during the second quarter, recent remarks from AT&T CFO Pascal Desroches suggests some moderation in the positive direction – cash collection cycles remain “within the company’s expectations and (are) largely consistent with normal pre-pandemic levels”, underscoring continued resilience to the business that might be pointing to better near-term prospects than previously expected.
With low churn on pricing increases implemented in May, and related pricing gains to become more prominent in 2H22, alongside promotion-driven demand spurred by the newest iPhone 14 release as well as seasonal demand over coming months (e.g., back-to-school; holiday sales), AT&T is expected to benefit from a fundamental boost in the near-term, providing support for current valuation lows at 2.4x forward EV/sales and 7.0x forward price/earnings.
Improved Payment Collection Cycles
In AT&T’s latest earnings call, the company had decided to slash its free cash flow guidance from $16 billion to $14 billion. At the time, management had alluded to lengthening consumer payment collection cycles and related bad debt expenses for $1 billion of the downward adjustment to forecast free cash flows for the year, underscoring the near-term macro uncertainties stemming from generational high inflation and tightening economic conditions ahead. Yet, management had remained confident at the time that related losses were not permanent, with the current collections situation being more of a timing issue as opposed to defaulting payments:
And as I said, this typically is not an issue of people not paying. It’s an issue of when they pay. And I don’t believe there’s anything in our credit scoring and how we’ve looked at our customer base coming in that would cause those trends to be dramatically different than a previous period.
In the latest turn of events, CFO Desroches had recently shared that “AT&T is not seeing any material incremental shift in its cash collection cycles, which are within the company’s expectations and largely consistent with normal pre-pandemic levels”. This provides grounds that while the earlier decision to slash free cash flow guidance for the year may have been appropriately conservative, an earnings surprise could still be within reach for AT&T later this year.
The optimism is further corroborated by the company’s expectations for a back-end weighted year, as mobility contract pricing increases implemented in May start to reflect in its fundamentals, driving sustained growth from its existing and still-growing postpaid customer base. Recall that AT&T has been benefited from relatively lower churn when compared with rivals like Verizon that have also recently turned to contract price increases to offset inflationary pressures. And despite T-Mobile’s efforts to take advantage of its rivals’ price hikes by introducing “Price Lock” – a commitment to “not raise the price of its existing wireless rate plans even as costs for everything else increase” – to encourage switches, AT&T has continued to anchor its market share gains with robust postpaid phone net adds that outperformed its peer group. The company reported postpaid phone net adds of more than 800,000 during the second quarter, beating T-Mobile’s 723,000 and Verizon’s 12,000 by wide margins.
The company’s cost structure in 2H22 will also benefit from lower capital costs after having offloaded a meaningful portion of its debt with the spinoff of its WarnerMedia unit in April, alongside with the realization of additional cost savings post-spinoff given its altogether exit from media and entertainment. Specifically, management has guided “strong visibility on achieving more than $4 billion of (AT&T’s) $6 billion transformation cost savings run rate target by the end of this year”, which provides a strong runway for investments into renewed growth in the company’s strategic shift in focus back to its roots in communications and connectivity services.
Promotional Boost
AT&T’s strategic management of its promotional efforts remains another competitive advantage that will help sustain continued market share gains by driving additional demand, overcoming near-term challenges posed by a weakening global economic outlook, while also providing greater visibility into its forward growth trajectory and margin profile:
In fact, looking at many of your commentaries, you’ve been articulating that others have been much more aggressive in the market and probably leaning in to promotional activity in a heavier way. And I would say, I would characterize our approach as being much more tempered and consistent with the past. And we have not really responded to that increased promotional activity that we’re seeing from others in the market right now… Industry growth in the first half of 2022 has been stronger than the expectations I shared with you late last year. In our view, this strong performance reinforces that our success is not solely promotion-led, but instead reflective of our improved value proposition in the market. Again, our customer growth performance was better than we expected, especially when you consider we became less active in promotional activities compared to others in our industry. So it’s clear to us that the strategic change we made to simplify our go-to-market strategy 2 years ago continue to yield great results and that our value proposition is resonating in the marketplace.
And as part of its “consistent” promotional roadmap, special offerings at AT&T correlated to Apple’s (AAPL) annual iPhone launch event are not to be missed. The strategic pairing has been a huge help to AT&T’s growth in the previous year:
Attractive “free-phone promotions” offered in 2021 have also helped AT&T promote the strongest multiyear upgrade cycle in a decade, boosting 5G network sign-ups needed to recoup their multi-billion-dollar investments made over the years.
Source: “AT&T Strong Gains Amid 5G Roll-Out Delays Indicate Unstoppable Momentum“
And similar trends are expected to repeat in the current year, especially considering the ongoing transition to 5G that has been buoying a multi-year upgrade cycle in smartphones, an increasing volume of switches to the iPhone, as well as increasing consumer sensitivity to discounts on discretionary purchases during the inflationary environment:
1. Sensitivity to Promotions
In light of Apple’s recent launch of its newest iPhone 14 family of smartphones, AT&T has once again whipped out free phone offerings to attract new sign-ups to its 5G-supported unlimited plans. This time around, iPhone 14 Pros are given out to customers on the house if they subscribe to select unlimited plans (starting at $65/month AT&T Unlimited Starter Plan) and make an eligible trade-in. Trade-ins starting with the 68 GB iPhone 11 are eligible for a rebate of $800, while trade-ins starting with the 64 GB iPhone 12 will be eligible for a rebate of $1,000, covering total costs for the standard 128 GB iPhone 14 that starts at $799.
This makes the most attractive offer when compared to rival T-Mobile and Verizon’s offerings. T-Mobile is currently offering customers with free iPhone 14 Pros with both an eligible trade-in and subscription to its $185/month Magenta Max unlimited plan; iPhone 12 trade-ins are only eligible for a $799.99 rebate at T-Mobile, compared with the $1,000 rebate at AT&T. Meanwhile, Verizon is only offering up to $800 in rebates on eligible iPhone trade-ins and subscription on select 5G Unlimited plans that start at $90 per month, although it includes additional access to the Apple One service bundle that combines Apple Music, Apple TV+, Apple Arcade and iCloud+ ($14.95/month value).
Consumers have already exhibited characteristics of heightened sensitivity to recent price increases – more than three-quarters of shoppers surveyed by Adobe in June indicated they have been searching the web for the best deals and discounts to “maximize their spending power”. With AT&T offering the most attractive iPhone 14 phone plan ahead of the U.S. telco trio’s annual promotions arms race, the company is well-poised to benefit from greater consumer demand. And past performance indicates that the company has continued to benefit from discount offerings, turning them into a positive value-adding strategy that locks in greater long-term visibility into both revenue growth and margin expansion through scale, which assuages concerns that AT&T’s attractive iPhone 14 promotion might impact its near-term profitability.
2. 5G Upgrade Cycle
While global smartphone connections are expected to increase at a moderated compounded annual growth rate (“CAGR”) of 4% over the next five years, with the U.S. market being one of the largest drivers, resulting data consumption rates are expected to surge at a CAGR of 26.9% through to 2025. Meanwhile, global demand for 5G-enabled devices is expected to grow at a CAGR of 38% over the same period as users continue to transition to the new and faster network. With the average iPhone upgrade cycle being approximately three to four years, and the installed base for its 5G-compatible models (i.e., iPhone 12 and later models) being less than 20% penetrated, AT&T remains uniquely positioned to monetize on related trends and benefit from continued demand for its higher-priced and more profitable 5G supported unlimited plans.
3. Switches:
Switchers will also be a critical contributor to promotional-driven demand at AT&T. iPhone market share has continued to grab market share from rival operating system Android – more than half of Americans now use an iPhone, up from 45% in 2021 and 40% in 2020. Paired with AT&T’s attractive annual promotions on new iPhone launches, the company is expected to see postpaid phone net adds grow in tandem with Apple’s robust iPhone take-rates, which have largely remained resilient despite weakening patterns observed across the broader smartphone market.
Final Thoughts
Based on the foregoing analysis, AT&T’s continued growth and margin expansion trajectory at a five-year CAGR in the 2% to 3% range is expected to be sustained given its prudent management on forward market share gain visibility. With the stock now trading near historical low multiples (2.4x forward EV/sales and 7.0x price/earnings) last observed during the depths of the pandemic in early 2020, which is not reflective of its resilient growth prospects on a relative basis to peers (Verizon: 2.6 forward EV/sales, 8.2x forward price/earnings, 1% to 2% range forward growth; T-Mobile: 3.6x forward EV/sales, 31.3x forward price/earnings, 2% to 3% range forward growth), AT&T remains well-positioned for a valuation recovery backed by anticipated strength on near- and longer-term fundamental performance.
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