AT&T Stock: We’ve Never Seen Something Like This (NYSE:T)

AT&T Inc. (NYSE:T) continues to be a name we own, most recently buying heavily as the stock breeched $15, as the stock had been obliterated. Despite having long owned the stock, it continues to surprise us. Management has surprised us as well, generally in negative ways. But did we catch a bottom, or just a short-covering rally after AT&T just reported earnings?

Folks, we just have not seen something like this before. AT&T actually saw a huge 10% rally on earnings. Just does not happen. That is a big move. Let us keep things in perspective here. The stock has only regained ground that it lost over the last few weeks. However, the action is promising, as management seems like it is finally understanding that investors have been slaughtered owning this stock.

We had lost a lot of money, all before abandoning the stock in the $20s, only to repurchase shares lower. Here is the thing. This quarter, it was something to behold. There were some very critical successes, and some outright surprises led by a guidance hike. Yes. A hike. Great moves for the stock as we were recommending weeks ago to buy shares this low for income, possible appreciation, and for those who know how to do it, some option premium trading income. For those who may have sold covered calls, now would be a good time to roll your covered calls.

It was a borderline homerun, at least from the Street reaction. In some respects it was on some line items, in other areas, there are still struggles. But we have not seen something like this move higher in AT&T. We suspect the stock fades some of it if the market continues to be weak, but it was much welcomed for investors who have been beat up, and for traders like us that love to pounce on beaten down names.

We continue to believe AT&T is a great income stock. Despite the terrible short, even medium-term bearishness the last year, we are long-term bullish. Let us discuss.

AT&T Q3 results in context

The market was nervous about this earnings season. And yet, early on in the first real week of Q3 earnings reports, for the most part corporate earnings have been strong this earnings season. But AT&T gave the market something we have not seen in sometime out of them. A beat and raise, and a big rally in the stock. It is welcomed, for sure. Management is taking proactive measures, such as selective pricing adjustments, to address the high inflationary pressures that are out there. We expect to see an ever-evolving pricing strategy to allow even the most loyal of customers to take advantage of special offers, while attracting new customers. The beat and raise was a surprised given how promotional we thought the company would be, in conjunction with the massive cost pressures in its business.

In the conference call, the CEO noted that such pressures were being handled efficiently:

“This is one reason why we focus so intently on reorienting our business, whether it was asset dispositions, investing in cost transformation or our proactive decision to address rising inflation through a measured pricing strategy. As a result, our balance sheet has improved, our network performance continues to get better, and we’re now seeing some benefits to our profit trends. This is a direct result of acting when we did and how we did it.”

AT&T has indeed improved its financial position, but the fact is that they need to continue to push cost-savings programs, or else you can expect ongoing earnings pressure into next year. This quarter, they delivered. Getting promotional to attract customers only partially offsets the impacts from higher costs. We have never seen something like this.

One particular comment in regards to the performance by the CEO effectively covered the success of Q3:

“…. we’re beginning to see savings start to contribute to the bottom line. We’re transforming our business as the world continues to face what feels like a period of uncertainty. Many of the economic trends that we spoke about at the start of the year and the assumptions that we’ve been operating under are now coming to fruition….. “

Basically, management has already been operating like the economy was in a recession. This has paid off.

AT&T reports a Q3 revenue beat

Overall our revenue expectations for Q3 2022 were slightly more liberal relative to consensus. Analysts covering the company were targeting a consensus of $28.6 billion. We expected revenue to be closer to $29.5.0-29.80 billion range on the belief that the company would face declines of 4.5-5.5% on revenue with a result of the pressure from being promotional. With $30.0 billion in revenues, this was a beat of $140 million vs. consensus, and a beat vs. our expectations. Let’s dig in some more to the numbers.

Revenue drivers

Wireless postpaid growth saw 0.708 million adds, and these were once again boosted by 5G availability and the specific promotional marketing strategies employed by AT&T. AT&T also reported 338,000 Fiber net adds. Both of these numbers are strong, with the former expected to be industry leading. The fiber adds were the second-best in company history. Just have not seen this kind of strength lately. Impressive in this environment. We have never seen anything like the level of customer additions following reports earlier this year of growth. For 5G, they are now on track to hit 130 million people. This is 30% ahead of what management had previously expected for 100 million, and nearly double the initial 2022 forecast for 70 million. Wow. This is the type of boost the company needed to get investors motivated again.

AT&T Q3 earnings outperformance

Once again, the top line performance helped drive the bottom line to a beat versus consensus. Analysts were looking for $0.61, and this was surpassed by $0.07 solid. While we applaud the cost reduction efforts, expenses still remain higher than we would like. Operating expenses were $24.0 billion. While this is down from last year and down from the sequential quarter, we need to see these expenses come down more to maintain earnings. Operating income fell from last year to $6.2 billion, even with adjustments for restructuring. Overall, we are moving in the right direction.

We like AT&T as a dividend play. One concern was declining free cash flow. But free cash flow will again be more than sufficient to cover the dividend, and the all important payout ratio will remain safe.

With the outperformance, management updated its outlook. Full year EPS is now expected to be $2.50 or higher. This is up from the $2.42-$2.46 prior view.

AT&T Q3 free cash flow covers dividend

This is an income name for us. Taking that into account, free cash flow is key to covering the dividend payment. Up until 2022 we had not seen issues with coverage in years frankly. In Q2, AT&T reported a disaster for this metric, with just $1.4 billion in free cash flow. We thought Q3 free cash flow would be $2.0 to $2.5 billion, considering cash from operating activities of $9.5-$10.0 billion and capex spending of $5.7-$6.0 billion. We were off slightly on our expectations as cash from operating activities were $10.1 billion, and capex was high again at $5.9 billion, while total capital investment from operations was once again a high $6.8 billion. However, free cash flow was in line with expectations at $3.8 billion.

The CEO elaborated on the call some more:

“Our free cash flow for the quarter was in line with our expectations despite higher third quarter capital investment spend, and we’re on track to deliver on our previously stated $24 billion capital investment plan for the year. At the same time, we hope this healthy free cash flow for the quarter gives you confidence in our ability to achieve our target for free cash flow.”

Free cash flow improved from $1.4 billion in Q2 to $3.8 billion and this means the dividend was covered.

Dividends paid were $2.01 billion, so there was about a $1.83 billion in excess free cash flow after the dividend million shortfall. The payout ratio was a very comfortable 52.3%. As an income investor for the long-term this is critical. Now that said, for the year, the payout ratio so far is a risk 97.6%, largely due to the Q2 2022 shortfall.

But the reassurance from the CEO is meaningful. He even recognized that AT&T needs to do a much better job to regain investor confidence. But it is a fine balance. On the one hand, the company is investing massively in itself to grow and to attract customers. We expect revenue to improve, but cash flow still is expected to be just $14 billion for the year. This means Q4 needs about $5 billion in free cash flow to hit the goal. While the payout ratio is “less safe” than we saw in prior years, the dividend is still covered despite heavy investment.

AT&T debt update

We cannot mention AT&T without talking about the debt load. It is by far the biggest risk to the company, especially with rates rising so much. Future debt payments could be very high. It is a problem, and one of the biggest risks with holding AT&T stock through this period. We will say that the company had been chipping away at the debt and improving the balance sheet by selling off assets and paying down its debt. Coming into Q3, net debt was $131.9 billion, and that translated to a net debt-to-adjusted EBITDA of 3.23x. We want to see this ratio come down a lot more. At the end of Q3, net debt came down $800 million and was $131.1 billion, with net debt-to-adjusted EBITDA of 3.22X. There is still a lot to do here.

Final thoughts

We started buying big a few weeks ago. This is an income name, but capital appreciation is welcomed. We endorse options trading around a core position as well. Make no mistake, this is a battleground stock. But this report was strong. Seeing the dividend barely covered for the year is definitely something we have not seen in a long time. This all comes despite operational excellence on the headline results. But the issue is that management has been paying up for this growth.

Final take? Short-term bearish, long-term bullish for this income name. Let it come down heavily toward 52-week lows, then hold your nose and buy. For now, expect selling pressure.

Your opinion matters

We love to hear your thoughts on the latest update. is AT&T still junk? Do you think this rally is doomed? Is the debt insurmountable? Have a good options approach? What is your take? Let the community know below.