RichLegg/E+ via Getty Images
We started aggressively buying AT&T Inc. (NYSE:T) when it hit $14, and we have updated you along the way on why we liked telecoms at these levels. As we know, the high debt in this environment is the clearest risk, but cash flow remains strong, and the two telecoms we have recently bought this year, T, and Verizon Communications Inc. (VZ), are covering the dividend and continuing to raise it. We own them both for the income, but do see future capital appreciation, and closed out a very nice trade in VZ late last year.
AT&T’s stock has rallied nicely into 2024, although shares seem to be taking a breather before the upcoming earnings season. AT&T, as well as hundreds of other S&P 500 (SP500) companies, will report earnings for Q4 later this month (T earnings are expected pre-market January 24th). In this column, we provide our projections for AT&T’s Q4 performance and highlight what we are watching for in the report.
We think the guidance is really going to determine if T shares can make a meaningful run toward our $19 price target. You can be a winner if you know what to look for operationally and then how to trade it. Remember those “For Dummies” books? This column is set that way to show you what to look for in this oddly controversial stock, one that we have a fantastic history with.
Cash flow is king, revenue sets the tone
The most important figure we will watch for is cash flow. It drives a lot of the trading in this stock because the dividend, of course, is so reliant on it. We are pretty bullish for the Q4 holiday season earnings and expect significant promotions to drive subscriber numbers higher and drive revenue toward the high end of the expected range. We are looking for $31.4-$31.7 billion in revenues in the Q4 release. Keep in mind that any boost from the new iPhone will be reflected this quarter. Revenue will set the tone. If it lands in our range, we expect strong cash flow.
Again, cash flow is the key indicator we watch for with our telecom investments, and for most companies really. For the telecoms, the stock trades with cash flow. Weak cash flow translates to weak stock action, while strong cash flow, or better than expected cash flow, often drives shares higher. If you are in the name of income, and if you are a trader like the ones in our community, then you are likely also selling some covered calls each month to help ramp up income.
Ideally, we want shares to move sideways to slowly higher when owning a name like this. Collect the dividend for income, and hopefully do not get called away. Hint, if you do not want to be called away, roll those covered calls out to higher strikes a month or two out. Anyway, we saw a long decline in shares of T when cash flow numbers were poor for several quarters, and shares started to come back when cash flow numbers and the outlook improved in the back half of 2023. Bottom line? Investors regained confidence in the dividend, and it’s being covered.
Not only do we like cash flow for dividend coverage, but more revenue and more cash flow means more available to tackle the mountain of debt. The company has sold off a lot of assets and will continue to do so. But there is only so much that can be sold off, even for a company of this size before it would harm the company’s earnings power.
That said, cash flow, and items down the balance sheet all start with our revenue target. Back in Q3, analysts covering the company were targeting a consensus of $30.25 billion, and this was surpassed by $100 million with revenue of $30.35 billion. For Q4, the consensus is $31.44 billion, so that is the benchmark from which to gauge performance. As we indicated above, we are more bullish than consensus with our range.
We were looking for 0.450 million adds in Q3. AT&T also reported 0.272 million fiber net adds in Q2, and we were looking for 0.260 million in Q3. Well, total phone net adds (postpaid and prepaid) were 494,000, so this also surpassed our expectations. Postpaid subscriber net adds were 550,000, with phone net adds of 468,000, ahead of our estimate. This also helped drive the revenue number higher. Prepaid subscriber net adds were 56,000, with phone net adds of 26,000, which was below our estimate by 4,000, but essentially in line.
We are looking for 0.600-0.650 million adds in Q4. For fiber net adds we are looking for 0.250 million in Q4. Consumer wireless service revenues should be up 1-2% while business wireline revenues, are likely to dip 1-2%, however exact performance is quite variable. Overall, expect mixed results, but these segments should drive an overall 1% plus gain in total revenue. Assuming operational expenses commensurate with Q3, we also expect earnings of $0.56-$0.60 per share. This actually would be a slight decline from last year’s $0.61 in EPS, though that was a very strong quarter that saw a $0.04 beat. Cash flow was strong in Q3, and we see that continuing in Q4.
Free cash flow
Free cash flow specifically will be of interest, as this is how we gauge the dividend’s margin of safety. It is, of course, critical to cover the dividend payment. In Q3, cash from operating activities hit $10.3 billion, reflecting operational growth and timing of working capital. CAPEX was $4.6 billion, and when including $1.0 billion cash paid for vendor financing (which varies heavily from quarter to quarter), capital investment was $5.6 billion. The free cash flow generated was $5.2 billion, and we came into Q4 a full $2 billion higher for cash flow year-to-date for 2023 versus 2022.
For Q4, we will once again see positive dividend coverage. Assuming cash from operating activities of $10.5-$11.0 billion, capex of $4.0-4.5 billion, and unknown estimates for additional financing, we are targeting free cash flow of $5.9-$6.3 billion. Once again this will be easy coverage of the dividend payments of $2.1 billion, which would be a 34% payout ratio at the midpoint. For the year, the payout ratio should be in the low 60% range. The dividend is secure.
Here is the thing. The $0.28 quarterly dividend has been maintained since the Warner spinoff, but there is room to increase it. Of course, from a debt perspective, among other reasons, there are positives to arguing that management should cut the dividend. For an interesting read on what would happen if the dividend was eliminated, we once again invite you to review this classic piece.
With a sub-50% payout ratio this quarter likely and a 60% payout ratio for the year, the AT&T Inc. dividend likely is not getting cut. To think it will be cut from a safety standpoint is ludicrous. Just ludicrous, even with the huge debt burden. And yes, we will watch the debt. It never seems to go away, and in the future, there will be more capital needs, updates, spectrum auctions, etc., all of which require financing.
Yes, borrowing rates are much higher now, and we acknowledge that risk. This is a reason why the dividend is likely to be held firm, even if there is wiggle room based on the free cash flow. So, of course, when Q4 is reported, we will eye progress on the massive debt burden. Over $20 billion in debt has been reduced in the last few years by the company. We started Q4 with $132.0 billion of net debt considering cash. Total long-term debt was $126.7 billion at the start of Q4. We are looking for it to dip to $125 billion.
Keep in mind that by 2025, AT&T should knock this leverage down well under 3.0X for net debt-to-adjusted EBITDA, so we may see even more progress. Ultimately, management has set a goal of 2.5X.
Final thoughts
In the spring and early summer, we came back to AT&T stock with a strong buy conviction. We see it as a solid income name with a secure dividend and a name where you can boost your yield to over 10% a year with an options approach. We have seen capital appreciation since we turned bullish.
Here is our rating history since the end of Q1 2023, where we were bearish, and then turned bullish.
Quad 7 Capital T stock rating history
We also see further capital appreciation as likely, and maintain a $19 target, especially if the company delivers on debt reduction. Watch for cash flows, they are the key. Finally, while the performance will matter, it is all about the 2024 guidance. A free cash flow guide of at least $17 billion-plus should be interpreted very bullishly, as well as any updated progress on leverage reduction. A free cash flow guide of $15-$16 billion will likely be met with neutral to slightly bearish reactions, and less than this would be bearish, in our opinion. CAPEX will be a key driver of this guide.
Your voice matters
Do you take our approach and generate extra income from your holdings like we do at our service? Are you a buy and hold forever investor (not buy and forget)? Do you trade around the core position shaving gains and buying dips? Do you see a downside ahead? Is $19 a reasonable target for AT&T Inc. stock? Let the community know below.
