AT&T: New Cash Model Asserts Next Quarter (NYSE:T)

AT&T Inc. (NYSE:T) never got credit for the new cash flow model now that management has divested all non-core businesses. The last article noted how the excitement over cash flow results likely meant low expectations. This means that the next quarter could produce a rise in the share price again, as cash flow should increase seasonally again.

The business itself remains in the midst of several transitions. There’s 5G rolling out as quickly as possible. On the other hand, I just received a notification about the possible end of service for my landline. Of course, that shows my age too. Eventually, the decline in “older” business will become less significant, while the growth in new business continues to become more significant. This should ultimately lead to the company’s overall growth a bit faster than is the case now. In the long run, this bodes well for higher cash flow.

The share price itself has largely responded to the cash flow situation as shown above. There could be a dip in the seasonally weak first quarter. But that’s far enough away from the current situation that it may not have an effect on the stock price just yet.

But if management continues to grow the overall business in the single digits, then the stock price direction should be bullish over the long term. In the short term, the continued focus strategy should allow both EBITDA and free cash flow to grow faster than the business in the first few years.

Debt

There were some concerns about the level of debt.

Based on the feedback, the main concern I am getting is that the debt is not being paid off quickly enough. But there is also the need to transition the business to 5G and of course to grow the mobile phone or any wireless business.

There is always some risk of not repaying the debt because the company can be caught in the “high-tech carousel” in that continuous improvements result in the cash flow generated from operations always being invested in the latest technological upgrade. This, of course, affects future free cash flow to the point where any debt is never repaid.

However, the growth of the business should indicate that there will be more free cash flow going forward, even if the percentage of cash from operations that becomes free cash flow is a smaller percentage. The fact that the debt ratio is now below 3 should indicate steps in this direction “just in case”.

Furthermore, despite the long wait, there is a debt repayment shown above, resulting in a fairly small amount of debt reduction. But it still has to be a step in the right direction, even if progress in that direction is painfully slow for shareholders.

INCREASE

Meanwhile, businesses slated for growth are on the rise. What needs to happen is that the decline in legacy business needs to become less significant for the growth business to predominate. To some extent, the combination of business focus and growth about to be posted resulted in low single digit growth. What should happen going forward is that the growth areas in the future become the growth of the whole business.

This business (and cell phones) usually has a pretty rough fourth quarter. It’s generally the basis for a lot of free cash flow in the quarter. Much of what is sold in the fourth quarter causes a seasonal spike in accounts payable that reverses in the first quarter of the next fiscal year. Note that the company tracks people who do this, plus cell phones.

The only risk here is that this business becomes generic and the company runs out of newer, more expensive “toys” for consumers to pay for in the future. At this point, it seems unlikely. But it is a normal prediction of the business cycle that this business will become generic in the future and eventually be replaced by a new technology that we currently have no idea about.

This is presented further as there is a good chance that the slippage from before will be the future driver of growth in this area. It can actually be the differentiator when it comes to competing services, as bundling can be the important part for consumers (cost savings).

The question is always the challenge of retaining subscribers.

Probably the main point here is that the management has successfully transitioned from a landline company to the latest technology. It was a mess and there are many mistakes to point out. Most transitions are unfortunately like that. It’s one reason why few companies survive to the “next generation”.

In the business world, the goal is probably to do more good than harm. Here “right” seems to prevail. For AT&T, the business side of the company still appears to be transitioning from wireline services to a mobile phone system. Transition still seems to dominate (as opposed to new product growth).

Summary

As shown by the second quarter stock price reaction to the cash flow news, the market has very low expectations for this company. This could mean continued relatively strong price performance in a very tired market that is now centered on a few stocks. Once a stock market correction begins, this company has the advantage of a focus strategy and new growth areas that will be in full swing.

This company remains a strong buy as the future looks to have a lot of good news ahead of it. A potential period of weakness going forward appears to be the first quarter, where there are a lot of one-time payments for the fiscal year that decimate free cash flow on a seasonal basis. This can be something that traders can take advantage of.

But for income investors, it now looks like the dividend will not only be sustained, but will slowly increase going forward. A previous slide shows a dividend yield that accounts for most of the total return that many investors report over the long term. As a result, the stock price only needs to appreciate a small amount for investors to get that average annual return that many report over the long term.

This remains a strong buy as it should eventually grow in the upper single digits, up to 10% per year, while averaging around 7% per year, combined with the current dividend yield of over 5%. The current price earnings ratio of 9 could easily expand to 13 to 15 in a scenario like this as well.

The continued return seems to indicate that this investment opportunity will provide a teenage compounded return for at least the next five years. At least in the near term, both cash flow from operating activities (the GAAP number) and free cash flow should grow faster than revenue as the company continues to focus on its remaining core activities to become “lean and petty”.

risks

Arguably the major risk is a sustained period of high inflation that increases the cost of carrying debt. Added to this would be an inability of the company to recover costs that would allow results to keep up with this high inflation. At this point, that seems like a distant possibility. But a key step in that outlook will be in 2025 how the expiring parts of the tax cuts are handled, combined with what is done to reduce the ongoing federal deficit.

There is always the risk that a new technology will completely overtake the company’s business. The last time this happened, when cell phones came out, management barely made more right decisions than wrong decisions to enable the company to recover from the decline of the landline business. Even if investors can’t imagine what that future will look like, it could still happen.

The loss of key personnel could reduce the company’s recovery trajectory.

When it comes to valuation, realize that valuation is highly dependent on market conditions when we get there. So while I can estimate a future valuation using current market conditions, there is no guarantee that those conditions will exist five years from now. What I think I can say for sure is that the ongoing shift is becoming apparent to the market in such a way that future positive quarterly comparisons (probably) should allow this issue to overcome a fair share of the market as the current price-to-earnings ratio is with well below the market average and should indicate low (or no) expectations.