AT&T Stock: Revisiting The Bull Case After Q4 Earnings (NYSE:T)

AT&T (T) has been plagued by chronic underperformance and a heavy debt burden. However, after a dismal 2021, the stock began looking interesting in the low $20s.

We digest Q4 2021 results relative to the current stock price to decide if it is worth going long here.

AT&T Stock 2021: Improved Fundamentals

Despite the very poor total return performance in 2021 – especially compared to the broader stock market – management pointed out on the Q4 earnings call that the company still improved its underlying fundamentals in 2021. For example, AT&T added 1 million additional fiber subscribers, 13 million additional HBO Max and HBO global subscribers, and achieved over $3 billion in run-rate cost savings during the year.

On top of that, the company announced or closed more than $50 billion in asset monetization as a major step towards streamlining the business and deleveraging the balance sheet while also generating nearly $27 billion in free cash flow during the year to fund its hefty dividend and deleveraging efforts.

AT&T Stock 2022: Further Improved Fundamentals & Business Simplification

Looking ahead to 2022, AT&T expects fundamentals to continue improving, with expected 3% wireless service revenue growth and $23 billion in free cash flow generation. While this free cash flow number is nearly $4 billion less than what the company generated in 2021, it is still a 12.8% free cash flow yield relative to the current market cap and is largely the result of aggressive investments in streaming content and building out the company’s network, which should lead to growth down the road.

The company also expects to add an additional $1 billion of its total target $6 billion in run-rate cost savings and also expects to continue deleveraging with free cash flow and getting rid of a large chunk of debt via that spin-off of its media business to put it on course to achieve a net debt to EBITDA ratio of 2.5x by the end of 2023.

AT&T Stock Dividend Questions Linger

Meanwhile, one of the biggest question marks hanging over the stock right now is exactly what its dividend policy will be post spin/split off of the WarnerMedia assets to Discovery (DISCA). Management stated on the earnings call that AT&T will be paying out a total of between $8 and $9 billion in dividend, though the exact number of shares outstanding and the exact amount per share remains up in the air.

While the total number of shares outstanding at the time of the new dividend policy will obviously have a significant impact on this, for now if we assume that the shares outstanding remain the same as they are today (7.141 billion), and we assume a dividend payout at the midpoint of management’s guidance range ($8.5 billion), we assume a dividend per share of $1.19. This amounts to a hefty 42.8% dividend cut, even if the share count does not increase. Obviously, if the share count increases and/or management pays out a dividend that is on the lower end of its guidance, this dividend cut could become even greater. Furthermore, a $1.19 dividend would be a 4.7% yield relative to the current share price, which seems a bit low for what has essentially become a little to no growth core business.

However, current shareholders will also receive shares of DISCA as part of the spin-off. Based on current calculations, those shares should be worth around 25% of the current share price, so it should increase the effective dividend yield accordingly. As a result, we expect an effective ~6.5% dividend yield to remain in place post transaction for investors who buy at the current share price.

AT&T Stock Valuation Analysis

While the dividend yield should remain reasonably attractive, it will still be declining substantially from the current 8.25% yield.

Furthermore, there are plenty of other important valuation considerations to keep in mind here. For example, while the 12.8% forward free cash flow yield looks remarkably attractive in a world of low interest rates, shares look a lot less attractive when we examine the enterprise value to EBITDA ratio. Relative to its 3-year average, the company remains overvalued at 7.63x compared to 7.47x.

On top of that relatively unappealing EV/EBITDA ratio – which accounts for the company’s hefty leverage when looking at the valuation – the company is only expected to generate mediocre EBITDA growth (requires registration) over the next 5 years despite all of the free cash flow being retained by the company. In 2022, EBITDA is expected to decline by 4.2%, grow by just 1.6% in 2023, before reaching a consistent low to mid-single digit growth rate from 2024-2026.

Another way of looking at it is that EBITDA is only expected to increase by 11% (a 2.1% CAGR) over the next five years. Given that interest rates are expected to rise over that period of time and the valuation multiple is already at a premium to its recent historical averages, this means that AT&T shares are unlikely to see much capital appreciation over the next half decade apart from paying down a substantial amount of the debt portion of its enterprise value and/or buying back a lot of stock over that time period.

Investor Takeaway

AT&T is doing some good things: expanding its media, wireless, and fiber networks, harvesting efficiencies, paying down debt, and generating a large amount of free cash flow. Additionally, the upcoming spin/split off could potentially unlock value for shareholders by highlighting AT&T’s growth media business and streamline the focus on the core telecom businesses. Free cash flow generating is expected to remain strong for the foreseeable future, which gives management a path to continue deleveraging while still paying out an attractive dividend yield.

All that said, however, the company’s unappealing EV/EBITDA ratio and weak EBITDA growth profile combine to limit total return potential over the next several years. AT&T will likely still generate solid total returns when combining debt reduction and the dividend, but with interest rates poised to rise, it is unlikely that investors will see significant capital appreciation on an annualized basis over the long term.