AT&T Stock: Analyst And Investor Day Reinforces Financial Power (NYSE:T)

AT&T (NYSE:T) has got to be one of the most frustrating companies and investments of the past 5 years. On 3/13/17, shares of AT&T traded for $42.37, which seems like a different reality from where they are today. 5 years later, shares of AT&T have lost -45.29% of their value, declining $19.19 per share to $23.18. For T, the bull market never occurred, and management’s decisions couldn’t eradicate the dark cloud, which continuously overshadowed any positive traction created. In 2019, it seemed as if things were getting better as shares appreciated from $27.36 on 12/24/18 to $39.63 on 11/18/19, only to fall into a downward spiral that crashed through the previous lows in 2018. Much of the investment community has lost faith in AT&T, and to some, it feels as if it is becoming the definition of dead money. The chart is horrific and what could be worse is the public perception of AT&T.

The one aspect that has always baffled me is how the investment community could be so bearish on a company that consistently generates tens of billions in free cash flow (FCF). AT&T’s average annual FCF over the past 5 years has been $24.33 billion. The most basic goal of any business is to maximize profits for its owners or stakeholders. Somewhere along the line, investors disregarded fundamentals and financial analysis and looked to the combination of revenue growth and price to sales ratios as the key components of their decision-making process. Regardless of your opinion on AT&T’s previous business decisions or its debt level, the relevance of AT&T’s business and the power to generate cash from operations and FCF cannot be disputed. Every investment is the present value of future cash flow because when you buy a stock, you’re purchasing an equity stake in a company with the ultimate goal of generating profits.

AT&T just delivered an excellent Analyst & Investor Day, which outlined the strength of AT&T’s core business, their ability to generate cash from operations, and a clear plan of debt reduction and allocating capital to shareholders. If this doesn’t get the analyst and investment communities excited for the future, I have no idea what will. I have been 100% incorrect on shares of AT&T as the share price has continued to decline regardless of their financial power. Not even the huge dividend has been able to save investors, and I have dollar cost averaged several times over the years. After listening to the webcast, reading the transcript over, and reviewing the presentation, there is no doubt in my mind that AT&T is drastically undervalued. The problem isn’t with AT&T as a company, it’s with the public perception of AT&T’s stock, and hopefully, what was outlined at the Analyst & Investor Day event will be the turning point to a gut-wrenching story.

Highlights from AT&T’s Analyst & Investor Day

Before I go through my highlights from the presentation, I want to reiterate what CEO John Stankey led the day off with. AT&T, along with other companies, find themselves operating large scale businesses at a time when geopolitical tensions are immense, the easy money era is ending, risk throughout the economy is elevated, inflation hasn’t subsided, the supply chain inconsistencies are still relevant, and domestic tax and investment policies are shifting. If the operating environment in the spring of 2020 as the world faced global shutdowns wasn’t hard enough, today’s operating environment might be even tougher. AT&T is well-positioned to navigate the current levels of uncertainty as its products are essential to everyday life. AT&T is positioned to sustain strong cash flows with no pressing needs to enter the debt markets in the near term. Regardless of external factors, AT&T is in a position for its balance sheet and discretionary cash position to improve due to the financial strength driven by its products and services. This is a bullish insight into AT&T’s operations that shouldn’t be overlooked. As other companies fall on hard times, AT&T will generate billions in FCF, continue to invest in its operations, and business won’t skip a beat.

The entire transcript is 35 pages long and can be read here if you’re interested. The below bullet points are key components of AT&T’s operational business that I find to be important. To make this easier to read, I will bullet point the highlights from each aspect of AT&T’s presentation, then give my thoughts and grade AT&T on what they delivered to the investment community.

Network capital deployments – Jeff McElfresh

• Consumers need more data
• Their monthly consumption in their home is accelerating from 900 gigabytes, nearly a terabyte today, to 4.6 terabytes by 2025.
• We’re consuming roughly 30x more data in our home than we are on the go with our smartphones.
• The average household today has 13 devices, and that’s expected to triple by 2025.
• There is an immense expansion in streaming and gaming where higher resolution formats going from HD to 4K to 8K are becoming more of the standard.
• An incremental 35 million U.S. employees have the option to work remotely post pandemic and not just temporarily.
• Small and medium-sized businesses are also consuming more and more and expected to grow 3.5x in the next 3 years from 600 gigabytes to over 2 terabytes.
• Enterprises have shifted upwards of 80% of their entire processes from manual to digital in the past year.
• Dense fiber infrastructure is foundational to AT&T’s growth as it allows us to manage traffic on the most cost-effective technology.
• In fact, in urban and suburban areas, AT&T estimates there are roughly 50 million households and nearly 10 million business locations that are prime for fiber and are not covered today. This provides a strong growth vector for AT&T.
• AT&T is on track to double its fiber footprint by 2025.
• AT&T’s fiber network will be a strong growth platform, covering more than 25 million consumer locations, 4 million small businesses and 1 million enterprise locations with industry-leading multi-gig performance.
• AT&T will deploy its mid-band spectrum to over 200 million POPs by the end of 2023.

AT&T value proposition – Jen Robertson

• In 2019, AT&T added 483,000 net adds in an industry that added about 6 million. That’s only 8%.
• In 2021, AT&T grew its postpaid voice base by 3.2 million net adds.
• AT&T is growing subscribers at a record clip with record low churn.
• Based on net adds in 2021, AT&T was the fastest-growing prepaid carrier in the U.S. for the fourth year in a row.

Repositioning in business markets – Rasesh Patel

• In 2021, AT&T won 53% of postpaid phone flow share, the highest value business mobility service.
• Share leader in IoT connectivity and which is now a $1.3 billion business that is growing 18% year-over-year.
• FirstNet has rapidly grown into a $1.7 billion business, which posted 60% year-over-year growth in 2021.
• FirstNet connections has expanded to nearly 3 million among 20,000 agencies
• AT&T sees a 40-fold increase in connectivity consumption in these next-gen vehicle platforms and has recently signed long-term deals with GM, Ford, Nissan, Tesla, among others.

Cost transformation – Jeff McElfresh

• AT&T plans to reduce its copper footprint 50% by 2025. In doing so, we are rationalizing a cost base of $6 billion.
• To date, AT&T has turned down or decommissioned over 900,000 network elements programmed to date.
• AT&T has reduced over 4 billion in annualized kilowatt hours program to date.
• Today, 20% of its wireline footprint is served with fiber. By 2025, the goal is to improve this to more than 75% served by fiber and 5G, which represents the majority of our network surface area.
• The company has successfully migrated 1,500 applications to the cloud. This not only allows AT&T to decommission servers once again, but the process of migration alone forces a harmonization of these applications so that its product and platform teams can efficiently code enhancements allowing for the launch of new product capabilities in record time going forward.
• Embracing a flexible work schedule post pandemic, AT&T has been able to reduce real estate by nearly 15 million square feet.
• Commitments to deliver the $6 billion of run rate savings.

Sustainable growth – Rasesh Patel

• In 2022, AT&T’s expected $24 billion in capital investments will be its highest level ever.
• Starting in 2024, AT&T expects its capital investments to begin tapering to around $20 billion range as it surpasses peak levels of 5G investment and transformation.
• Shifting to fiber deployment. The company is currently spending in the range of $3 billion to $4 billion per year to target its goal of 30 million plus locations by 2025.
• Reduce its leverage by using free cash flows after dividends to pay down debt and thereby achieve the goal set for net debt to EBITDA in the 2.5x range by the end of 2023.
• Post transaction, AT&T’s expected annual total dividends of around $8 billion reflects a payout ratio of about 40% against its 2023 free cash flow outlook in the $20 billion range.
• For 2022, AT&T expects total revenue growth in the low single-digit range and wireless service revenue growth in the 3%-plus range.
• The company expects to reduce G&A support cost cumulatively by around $1 billion between 2022 and 2023.
• The expected free cash flow is $16 billion for 2022. AT&T’s adjusted EPS is expected to be between $2.42 and $2.46.
• Newly defined free cash flow guidance is $16 billion for 2022, which compares to about $19 billion in 2021 on a comparable basis. The primary year-over-year deltas include approximately $2 billion in higher expected cash taxes and about $4 billion in higher capital investments.
• Expect these factors to be partially offset by $1 billion in organic adjusted EBITDA growth and $1 billion in transformation savings.
• Expect about $1 billion in lower cash interest and working capital savings.
• Expect $4 billion in cash distributions for DIRECTV in 2022.
• Free cash flow expectations of $16 billion for 2022. Add to that an expected nearly $2 billion from interest savings from the WarnerMedia separation and the absence of 3G shutdown costs.
• In this scenario, starting in 2023, AT&T would expect to generate $54 billion of free cash flows over the next 3 years.
• $30 billion of this cash would be distributed to shareholders via common and preferred dividend as well as minority interest obligations.
• Over the next 3 years, AT&T would generate at least $24 billion in excess cash even if it doesn’t materially grow cash earnings.

Pascal Desroches – AT&T Inc. – Senior EVP & CFO

• We believe our company can grow meaningfully and sustainably on a consolidated basis for both a revenue and EBITDA standpoint.
• Another priority is to continue to reduce leverage by using free cash flows after dividends to pay down debt and thereby achieve the goal set for net debt to EBITDA in the 2.5x range by the end of 2023.
• For 2022, AT&T expects total revenue growth in the low single-digit range and wireless service revenue growth in the 3%-plus range. It expects broadband service revenue growth in the 6%-plus range. AT&T is also refining its adjusted EBITDA expectations to $41 billion to $42 billion range for the year.
• Adjusted EBITDA expectations are in the $43.5 billion to $44.5 billion range. Adjusted EPS for 2023 is expected to be between $2.50 and $2.60.

It looks like AT&T is sick and tired of being the laughingstock of the market. Management came out and delivered an outstanding dissertation on their business and explained the numbers operationally and financially thoroughly. My grade on their Analyst & Investor Day is 9.3. I would have liked to have seen some discussion about dividend increases in the future. Overall, this was a strong showing for management, and they stuck to financial discipline and investing in their core business.

A lot of people criticize AT&T’s debt level, and because of this claim, it’s an uninvertible company. I have often said that while it’s a mountain of debt, it’s immaterial as AT&T produces so much cash from operations and FCF that it’s completely manageable. AT&T addressed this in detail and told analysts that their goal is for a net debt to EBITDA in the 2.5x range by the end of 2023. Today, AT&T has $157.53 billion in net debt. In 2023, AT&T is expecting to generate between $43.5 billion to $44.5 billion of EBITDA. On the low end, with $43.5 billion of EBITDA, AT&T would need to drop its net debt to $109 billion to have a 2.51x net debt to EBITDA ratio. This means that over the next year and a half, it will eliminate $48.53 billion in debt, which is 30.1%. If AT&T’s business doesn’t grow and they are accurate with run-rate savings, FCF, and EBITDA metrics, they would generate roughly $54 billion in FCF from 2023-2025. If AT&T utilized half ($27 billion) to further reduce its net debt level and didn’t grow its EBITDA by $1, then at the end of 2025, their net debt to EBITDA ratio would be 1.89x. AT&T has debt, but they don’t have a debt problem. It is going to still generate an immense amount of FCF after WarnerMedia is spun off and has the ability to facilitate its current debt and the firepower to lower it.

AT&T is drastically undervalued, and I am going to illustrate this from a numbers-driven approach

Please look at this section with an open mind and free of bias.

I believe investors should look at buying stocks as if they were going to buy an entire company because when you purchase the stock of a company, you are buying an equity stake, no matter if it’s 1 share or 10,000 shares. If I presented you with two options which are represented in the table above, which company’s stock would you rather buy and why?

For me, the answer is simple, company A because it seems as if the market is undervaluing the company. Company B has a $74.23 billion larger market cap, but there isn’t a single metric that would justify this valuation compared to the metrics presented from company A. The only difference is that company B has $147.76 billion less in net debt, but this is a moot point. As company B generates $46.19 billion less in EBITDA, its net debt to EBITDA ratio is actually 0.45 larger than company A, while company A could allocate all of its FCF to the net debt and pay it off in 7.37 years while it would take company B 26.76 years. Company A has a larger gross profit margin, larger profit margin, generates much more EBITDA, FCF, and net income. With every investment that you make, you’re paying the present value of future cash flow. From a valuation standpoint company, A trades at 6.51x its FCF while company B trades at 161.75x. Based on the numbers, which would you choose?

Would it surprise you that Disney (DIS) is company B? Putting the numbers aside, would you now want to invest in company B because you’re buying shares in DIS instead of AT&T? From a numbers standpoint, the valuation of DIS doesn’t make sense but many would consider DIS a better investment than AT&T. This has been a major problem for long-term investors of AT&T, including myself. Many see the financial strength of AT&T, compare it to other companies and, based on the numbers, can’t figure out why its valuation is a fraction of other large-cap companies. At the end of the day, numbers don’t care what business a company engages in, only what type of financial metrics its operations can generate. In 2021, AT&T’s operations generated $41.96 billion in cash from operations while DIS produced $5.28 billion.

So what are investors left with after the spinoff occurs and will legacy AT&T still be undervalued?

After the spinoff, investors will be left with shares of legacy AT&T and shares of Warner Bros. Discovery (WBD). On the closing date of the transaction, which is expected to be the end of Q2 2022, shareholders of AT&T will receive an estimated 0.24 shares of the new WBD common stock for each share of their common stock. If you own 100 shares at the time of the spinoff, you will receive an estimated 24 shares of WBD on a tax-free basis which is expected to be listed on the Nasdaq. The combined entity representing WBD would generate $47.82 billion in revenue and $11.56 billion in EBITDA. Comparatively, Netflix (NFLX) has a market cap of $151.09 billion and generated $29.69 billion in revenue and $6.4 billion in EBITDA in 2021.

The baseline for Legacy AT&T is $118.2 billion in revenue. In 2022, you will be left with AT&T’s core business, generating around $120 billion in revenue, $41 billion in adjusted EBITDA, and $16 billion in FCF. Hypothetically after spinning off WarnerMedia, if AT&T’s market cap remained unchanged (this will not be the case), it will still look like a better valuation than DIS is today. AT&T would still trade at 10.35x its FCF compared to 161.75x of DIS, generating $14.52 billion more of FCF, and $30.44 billion more of EBITDA. You would also be getting a large dividend of $1.11 per share, which is a 4.79% forward yield by today’s price. Most likely, after Warner is spun off and AT&T’s market cap adjusts, the future dividend will be between 5 and 6%. You’re getting a lot for your money with shares of AT&T regardless of how much they’re hated.

Conclusion

After dissecting AT&T’s Analyst & Investor Day, I believe it was a major success. Management has a clear path and its pro-shareholder. I don’t know how long the negative stigma around AT&T is going to last, but I am considering adding to my position again before the spinoff. The market is seriously discounting shares of AT&T, and people citing AT&T’s debt simply aren’t doing the research. AT&T has a lot of debt, but debt isn’t the problem. Its problem is public perception because the stigma of failed acquisitions won’t dissipate.

Everyone hates to hear this time is different, but this time really could be. Management seems to be laser-focused on AT&T’s core business. Communication has become the backbone of society, and AT&T has become an integral part of the communications backbone. By the numbers AT&T looks drastically undervalued and post-split, Legacy AT&T will still generate $16 billion in FCF for 2022, which is expected to increase to $20 billion in 2023. AT&T is going to eliminate $48.53 billion of debt over the next year and a half, bringing its net debt to EBITDA level to around 2.5x. Investors will have shares in a top-tier streaming company that eclipses NFLX in revenue, EBITDA, and in my opinion, content. Investors will also have Legacy AT&T, which is a cash-generating machine with a dividend that should exceed 5% forward yield. AT&T may be hated, but the numbers are on the side of shareholders. Only time will tell if it remains a horrible investment or if this spinoff is exactly what is needed to unlock value.