AT&T stock: The market was wrong from the start (NYSE: T)

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AT&T Inc. Stocks (NYSE:T) have continued to rise after the completion of the media business split last month as investors are now ready to price AT&T’s free cash flow at a higher valuation factor. Shares of Warner Bros. Discovery, Inc. (WBD), however, recently hit new lows, indicating that the market has always been wrong about AT&T. With AT&T earning billions of dollars in free cash flow, the company’s stock could be an attractive investment during a recession!

Performance gap between AT&T and Warner Brothers Discovery

AT&T completed its spinoff and the WarnerMedia merger with Discovery on April 8, 2022. Following the separation, AT&T outperformed Warner Bros. Discovery. While this short-term performance gap is not indicative of future performance, it does show that the market is growing increasingly fond of AT&T, in part because of telecom’s huge free cash flow, yield attractive stock market by 5.5% and the evolution of the investment landscape. The content business is currently not highly valued by the market, which is likely related to the clouds of recession looming on the horizon.

Data by YCharts

AT&T has a high value in a recession, an attractive stock market return

AT&T represents better value for investors in a recession than Warner Brothers Discovery. Indeed, AT&T generates a ton of free cash flow. Investors value stable, predictable free cash flow much more during recessions than during periods of economic expansion. During periods of growth, investors are willing to tolerate higher risk, while during recessions, free cash flow becomes more important to investors. Now that the U.S. economy may be on the brink of a recession, that free cash flow weighs more heavily on investors who want to de-risk their portfolios. Due to the recent rise in AT&T’s stock price, the dividend yield has dropped to 5.5%, but AT&T remains an attractive investment for investors who want to buy an FCF-strong company without worrying all the time about valuation.

Beyond the short term, share buybacks

As I said in my last work on telecommunications, AT&T’s near-term priorities will be paying down its large debt, which will create a healthier balance sheet in the process. AT&T repaid $10 billion in bank loans in April and will use the majority of its free cash flow to pay down its huge debt that has accumulated over the years. While I don’t view AT&T’s debt as an existential risk, it will take telecoms at least a few years to stabilize their balance sheet.

Debt maturities


I expect AT&T to again initiate significant share buybacks by fiscal year 2024. The company will likely focus on paying down debt over the next two years. By fiscal 2024, however, the balance sheet could be much better and AT&T could resume significant stock buybacks. The prospect of share buybacks (or a higher dividend) could also help the stock revalue higher.

Dynamism of 5G/fiber activity

AT&T has a huge opportunity for growth in the evolving 5G and fiber markets. 5G and fiber are AT&T’s top growth drivers with strong net additions in both segments in the first quarter. AT&T’s fiber business saw 289,000 net additions in the first quarter of 2022, posting 23% year-over-year growth, in part due to a growing penetration rate. The fiber penetration rate was 37% in the first quarter, compared to 35% the previous year. Postpaid is also seeing strong momentum, with net additions totaling 691,000 in Q1’22.

Growth of 5G and fiber


Long-term growth trends support AT&T’s plan to invest $24 billion in its 5G and fiber capabilities in 2022 and 2023. Wide acceptance of remote working, the rise of 4K streaming, and the proliferation of devices are driving demand for more bandwidth, which AT&T can take advantage of. The pandemic has only accelerated these trends and demand for bandwidth has been skyrocketing since 2020.

Increase in bandwidth demand


AT&T’s investments in 5G and fiber are expected to result in a shift in revenue mix going forward, with 44% of AT&T’s wireline EBITDA expected to come from fiber and fixed wireless services. AT&T’s 5G and fiber opportunities are creating free cash flow upside for AT&T.

Evolution of the composition of activities


Cheap free cash flow valuation factor

AT&T said it was looking to generate $16 billion in free cash flow in fiscal 2022, which would be down $3.2 billion from fiscal 2021. The expected drop in the FCF year over year is the result of higher expected capital. investments in 5G and fiber infrastructure. AT&T launched an expense savings plan to help FCF grow, and it covers product simplification, network efficiency, and overhead repression. The plan is designed to generate $6 billion in cost savings by fiscal year 2023.

Market of free cash flow for the 2022 financial year


AT&T’s free cash flow is expected to reach $20 billion in fiscal year 2023. Based on the $20 billion in FCF expected next year, AT&T’s stock is currently valued at a ratio P-FCF of 7.2X.

AT&T rival Verizon (VZ) had free cash flow of $19.3 billion in fiscal year 2021. I estimate telecom can grow its FCF to $23 billion in in fiscal year 2022 and $25 billion in fiscal year 2023. Based on $25 billion of free cash flow, Verizon has an FY 2023 P-FCF ratio of 8.2X. From a free cash flow perspective, AT&T is a better deal than Verizon.

Risks with AT&T

A recession is likely to affect AT&T much less than Warner Bros. Discovery. Indeed, content consumption falls into the discretionary category, which often sees spending cuts during recessions. AT&T’s services, however, should see more stable demand patterns during a recession as customers won’t stop using 5G and fiber services. For this reason, I believe AT&T should generate stable dividend income during a recession. The biggest risk for AT&T, in the short term, is the balance sheet. AT&T has pledged to reduce its debt, and the company should see a much stronger balance sheet by the end of fiscal 2023.

Final Thoughts

The market has always been wrong about AT&T, but still underestimates the company’s free cash flow. Shares of AT&T surged after the split and significantly outperformed shares of Warner Bros. Discovery. I believe this performance gap is the result of investors now being more open to buying value stocks that promise high free cash flow and stable dividends as recession risks increase. Going forward, I expect AT&T to continue to outperform AT&T’s former content business and believe the stock is worth buying despite the recent rise in stock price. !

Julio V. Miller