On Wednesday, AT&T (NYSE:T) stock tumbled, falling about 4% after the company reported its first-quarter earnings. Earnings that were in line with analysts’ consensus estimate, lower-than-expected revenue, and a decline in DirecTV subscribers caused investors to be less interested in buying T stock.
I think the decline of AT&T stock created a buying opportunity , but we need to look at T stock a little differently than most other stocks. Specifically, investors should think of it as an income vehicle rather than a stock.
We could surely find a stock that provides a better overall return than T stock. That’s been true over the past year, and it will probably be true again in the future. As Microsoft (NASDAQ:MSFT), Honeywell (NYSE:HON) and the PowerShares QQQ ETF (NASDAQ:QQQ) all push higher, it’s hard to hold T stock instead of those alternatives.
Investors shouldn’t be all-in on AT&T stock. Their portfolios should be diverse and include names like MSFT, HON and QQQ. AT&T should be viewed as an enhanced bank savings account or CD. The stock has a 6.6% dividend yield, a yield that can’t be obtained at any bank. Such a yield would raise a red flag for most stocks.In T’s case though, I think think the company’s cash flow is large enough to ensure that its payout will not be cut.
While T’s debt load may keep a lid on the stock, let’s see how its free-cash flow will enable it to reduce its debt.
Breaking Down T Stock
AT&T earnings of 86 cents per share were in-line with analysts’ consensus outlook, while its sales of $44.88 billion missed the average estimate by $277 million. While its top line did grow almost 18% year-over-year, that growth was primarily driven by its Time Warner acquisition. AT&T missed revenue estimates for the second consecutive quarter and for the fourth time in its last five quarters. However, AT&T is not a growth story. It’s a cash flow story.
T’s DirecTV business is struggling with subscriber losses in a cord-cutting environment. However, T’s acquisition of Time Warner has been lucrative, not just on the revenue front, but primarily on the cash flow front. AT&T reported $11.1 billion of operating cash flow (OCF), up 24% YOY.
Of that, $5.9 billion became free cash flow after capital expenditures were deducted. The Time Warner acquisition helped AT&T’s free cash flow surge more than 110% YoY.
The company paid out $3.7 billion in dividends, leaving excess free-cash flow of $2.15 billion. That gave AT&T stock a FCF/dividend payout ratio of 63.3%. A year ago, the company had a FCF deficit of $241 million after it paid out dividends.
This is a big improvement in the company’s FCF situation and I think it makes AT&T stock attractive. It means the dividend is safe, while management can focus on paying down debt. Its Time Warner asset gives AT&T strong streaming content, and its cell phone business remains a consistent cash generator.
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At the beginning of April, T stock broke out, overcoming its downtrend resistance. However, after the company reported its earnings on Wednesday, T stock gave up those breakout gains. Now, though, the risk/reward ratio of T stock is favorable again.
The stock sits right near its prior downtrend resistance (depicted by the blue line). A close below this level could signal that more declines are ahead and would be an unfortunate development for the bulls. However, T stock also sits near several major moving averages, including the 50-day, 100-day and 200-day.
The 100-day, which is just above $30, is currently the lowest. Since AT&T stock closed below this mark last session, it has lost all moving average support, as well as prior downtrend resistance. If it drops below $30, things could get slippery.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell is long T.
