The intense devotion to AT&T (NYSE:T) has long struck me as odd. There is an attractive dividend here, admittedly. T stock, after a nearly 4% decline following AT&T earnings on Wednesday, now yields 6.3%.
But that yield is only rising because AT&T stock is falling. As of this writing, in fact, T trades at a six-year low just above $30. And dividend aside, I’m not sure what investors here see as attractive.
The ‘Ma Bell’ days are long gone. As AT&T earnings showed, the legacy businesses are declining across the board. The Time Warner merger offers some hope, but I wrote last month that it alone doesn’t make T stock a buy. On top of all of that is a heavily leveraged balance sheet, with AT&T debt totaling about 4x the company’s EBITDA (earnings before interest, taxes, depreciation and amortization).
This is a much more dangerous stock than many T bulls seem to realize. And Q2 earnings show why.
AT&T Earnings
From a headline standpoint, the news from AT&T earnings looks mixed. On the profit side, the news actually looks pretty good. AT&T earnings were $0.06 better than consensus, and at $0.91 rose a sharp 15% year-over-year. AT&T also raised full-year guidance to the “$3.50 range”, which management explained on the Q2 conference call meant the high end of $3.40-$3.50. That’s better than Street estimates of $3.40 heading into the release.
The top line looks a bit more disappointing. Consolidated revenue dropped 2.1% year-over-year, missing consensus by $300M (about 0.75%). But the miss was narrow, and would seem to be offset by the earnings strength. With T stock down 4% in morning trading, no doubt some investors see the sell-off as an overreaction.
Looking Closer
But an investor has to go beyond the headlines. And a closer look shows mostly negative news.
The EPS growth looks impressive at 15%. But pretty much all of the increase came from a lower tax rate thanks to corporate tax reform, a new revenue recognition standard and a $0.02 benefit from WarnerMedia. EBITDA, excluding one-time costs and the WarnerMedia contribution, was pretty much flat year-over-year. Margins did improve slightly on the declining revenue base. But this remains a business that, right now, isn’t showing any profit growth, and that’s not a new problem.
On the top line, the concern has to be that every segment saw a decline. Consumer Mobility revenue dropped about 1% year-over-year. The postpaid business added 46,000 subscribers — about one-eighth the number at rival Verizon Communications (NYSE:VZ). Churn was solid, at 0.82%
In Business Solutions, sales dropped a concerning 6.2%. Segment-level profit fell 4.6%. Subscribers in the Entertainment Group rose. But AT&T basically is swapping out more profitable DIRECTV customers for less-profitable and shorter-lasting DIRECTV NOW subscribers. Revenue in that business dropped 8%. International revenue and profits declined as well.
The Problem With T Stock
The numbers at the segment level highlight my long-running concern when it comes to AT&T. It’s a combination of businesses that on their own simply aren’t that attractive.
The wireless business is a low-growth and highly-competitive industry, with the four participants in a “circular firing squad” of endless discounting to poach customers from one another. Outside of T-Mobile (NASDAQ:TMUS), it’s been a terrible sector for investors, with VZ stock flat and Sprint (NYSE:S) down. The legacy wireline business is in secular decline. The international business is worth maybe $8 billion against a $230 billion market cap for T as a whole.
DIRECTV is facing significant cord-cutting pressure that isn’t going to abate. That’s an industry-wide problem: Comcast (NASDAQ:CMCSA) and Charter Communications (NASDAQ:CHTR) have also been hit hard. Moving customers from that offering to DIRECTV NOW mitigates some of that pressure, but it doesn’t stop the declines in both revenue and margins.
Simply put, these are not good businesses right now. That’s the chief takeaway from Q2 earnings (and it’s not a one-quarter issue).
Can It Get Better?
Admittedly, they key phrase there is “right now”. This can get better. WarnerMedia should add to profits in coming quarters (it was only on the books for 16 days in Q2). And as I wrote last month, the smaller AppNexus acquisition highlights the company’s long-term strategy. Managing customers across multiple channels — and backing those agreements with owned content — gives AT&T a chance to make its whole greater than the sum of the parts.
But it’s only a chance — it’s not guaranteed. And at some point, the fact that AT&T isn’t executing all that well has to matter. This is a stock that’s down 4% over the past decade — while the S&P 500 has risen 125%. DIRECTV is losing subscribers. AT&T has lost market share in wireless over time. WarnerMedia, outside of the crown jewel HBO, has real concerns about cord-cutting relative to its cable networks, most notably TBS and TNT. And, again, there’s a very heavily leveraged balance sheet — in a period of rising interest rates, no less.
In that context, AT&T isn’t that cheap. 9x 2018 EPS guidance and less than 11x free cash flow projections sound like cheap multiples. But for a company with a leveraged balance sheet and zero growth, they’re not. Right now, AT&T earnings aren’t good enough to support upside. That may change, but investors have been waiting a long time for change that hasn’t come yet.
As of this writing, Vince Martin has no positions in any securities mentioned.
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