AT&T (NYSE:T) stock has been on a steady uptrend in 2019. The shares closed yesterday at $34.86, up 16.7% for the year. From an income perspective, T stock is also a quality dividend stock with a current dividend of $2.04 yielding 5.92%.
Yet, despite T stock’s 2019 gain — it’s beating the S&P 500 index‘s 14.8% YTD increase — I am still of the opinion that AT&T is a buy at current levels, with plenty of upside in the coming quarters. Here are the factors that I expect to fuel the stock’s momentum.
Deleveraging and Free Cash Flows
As of June 2018, AT&T debt had surged to $180 billion with leverage of 3.0. Flash forward a year and the company has reduced debt by $18 billion to $162 billion. By the end of 2019, AT&T expects to pare that debt to $150 billion with leverage shrinking to 2.5.
I believe that reduction in balance sheet stress is a key trigger for T stock’s upside in the coming quarters. It is worth noting that the company’s TTM (2Q19) free cash flow is at $29.1 billion.
Even if free cash flow can be sustained around these levels, AT&T is well positioned to continue deleveraging at a rapid pace. At the same time, the company is positioned to increase dividends.
Welcome ARPU Change
Another positive development that is likely to ensure healthy free cash flows is an expansion in EBITDA margin. The company’s EBITDA margin increased to 37.6% in 2Q19 from 36.9% in 2Q18.
The EBITDA margin expansion in the entertainment segment is a welcome change with premium video ARPU growth at 4.7% in 2Q19 as compared to a 5.2% decline in 2Q18. Cost management in the communications segment also aided EBITDA margin expansion. This explains the positive stock reaction even as revenue in the entertainment segment fell marginally.
Coming back to free cash flows, if EBITDA margin expansion sustains, the FCF is likely to be higher in FY20. In addition, the management expects the capital intensity to decline in 2020 with relatively lower investment in content and network building. That will help in accelerating free cash flows as compared to 2019.
Deleveraging and dividend growth should trigger stock re-rating and upside.
The 5G Launch Trigger
It is expected that the global 5G market will reach $227 billion by 2025, growing at a CAGR of 111% during 2019-2025. Further, North America will have the largest market share of 44% by 2025. This presents a potential opportunity of $100 billion over the next seven years.
AT&T has been gradually rolling out 5G with portions of 21 cities already covered. The company plans a nationwide roll-out in the first half of 2020.
AT&T plans to reach 200 million people with its 5G network and subscriptions and devices would trigger revenue growth. However, AT&T is looking at businesses to drive profits than consumer subscriptions.
It is very likely that focus on businesses will translate into higher EBITDA margins. On the other hand, relatively lower pricing for consumers would trigger volumes growth.
Overall, AT&T is set to benefit having a first mover advantage.
Even from an infrastructure perspective, FirstNet, which is the nationwide public safety communications platform, will help AT&T with the wider roll-out.
AT&T expects to complete 80% of FirstNet by 2020 and the same infrastructure can be used to provide 5G coverage with a software upgrade. Therefore, the 5G roll-out can be faster and cheaper.
Final Words on AT&T Stock
AT&T is well positioned to deliver robust free cash flows in the coming years and that will reward investors through dividend and AT&T stock repurchases. Deleveraging will also reduce the balance sheet stress and interest outflow.
The launch of 5G network countrywide will provide another growth trigger for AT&T beyond 2020. It is likely that EBITDA margins will expand with the 5G roll-out. In particular, enterprise accounts will deliver profitability.
HBO Max, which will be launching in spring 2020, also promises to deliver incremental growth with high quality original content. It is being reported that HBO Max can potentially shell out $1.5 billion to secure the streaming rights for The Big Bang Theory and Two and a Half Men. With ample free cash flows, HBO Max is likely to be on a content shopping spree.
Considering these factors, I believe that AT&T stock is worth considering and the uptrend is likely to sustain in the coming quarters.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.