AT&T T released its fourth-quarter earnings report on Jan. 24. Here’s Morningstar’s take on AT&T’s earnings and stock.
Key Morningstar Metrics for AT&T
- Fair Value Estimate: $23.00
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Narrow
- Morningstar Uncertainty Rating: Medium
- Forward Dividend Yield: 6.27%
What We Thought of AT&T’s Q4 Earnings
AT&T reported extremely good customer retention that fueled surprisingly strong net wireless postpaid customer additions. The firm hasn’t changed its primary rate plans for some time, which has caused it to lose momentum in the marketplace, but existing customers have been sticky despite aggressive pricing from cable companies, like Charter Communications CHTR and T-Mobile’s TMUS “Phone Freedom” promotion.
This dynamic has been beneficial for AT&T’s margins and likely contributed to stronger-than-expected free cash flow. AT&T provided a far weaker outlook for earnings per share in 2024 than expected, but this was primarily the result of items that don’t impact cash flows, such as accelerating depreciation on some equipment and the impact of pension assumptions. The firm expects to grow free cash flow in 2024 despite higher cash taxes and a declining contribution from the DirecTV venture. AT&T has also announced wireless price increases this month.
The decision to raise wireless pricing on certain rate plans is a strong indication that competition in the wireless market is rational. The biggest reason to own wireless carrier stocks, in our view, is the belief that the T-Mobile/Sprint merger will allow for stronger wireless pricing without creating a new wave of competitive intensity. This means recent events, including fourth-quarter results, are welcome signs. Both firms also exceeded their free cash flow targets for 2023, demonstrating their strong cash generation capabilities.
AT&T didn’t make a ton of progress on debt reduction during the year, but the firm supported its dividend payouts while completing the last of the payments tied to the 2020-22 spectrum auctions. The company is now set up to meaningfully reduce debt leverage in 2024, which should add confidence that these firms can maintain their dividend payouts, which remain very attractive based on yield.
AT&T’s network investment will slow a bit in 2024, but it continues to expand both its fiber network and 5G coverage footprint at a solid clip. Building these assets should enable a unique set of capabilities over the long term.
Improving the balance sheet will take center stage for AT&T over the next couple of years. As a result, the firm is not in a position to capitalize on the attractive valuation of its shares through stock buybacks. This stands in contrast to Comcast CMCSA, which trades at a similar discount to our fair value estimate and is buying back stock aggressively. AT&T’s trading multiples have also improved recently. They are no longer far below normal levels as they were over the summer, when the lead-sheathed cable issue was in the headlines. We continue to expect lead cables will not present a major liability for the firm.
Fair Value Estimate for AT&T Stock
With its 4-star rating, we believe AT&T’s stock is undervalued compared with our long-term fair value estimate of $23 per share, which assumes the firm will deliver modest revenue growth and gradually expand margins over the next several years as its wireless and fiber network investments pay off. Our estimate implies an enterprise value of 7.5 times our 2024 EBITDA estimate and equals a 10% free cash flow yield based on actual 2023 results.
In total, we believe consolidated revenue can grow 2%-3% annually over the next five years. With stable wireless margins and an opportunity to improve consumer fixed-line profitability, we expect consolidated EBITDA will grow slightly faster than revenue, in the 3%-4% range. With lower capital spending and declining debt leverage, we expect AT&T will be able to steadily increase free cash flow despite higher cash taxes and a declining contribution from DirecTV.
We generally expect AT&T will be able to reduce capital spending over the next couple of years as its mid-band spectrum deployment wraps up. We assume capital spending will roughly match management’s current plan in 2024 (around $22 billion, including vendor financing payments), decline slightly in 2025, and then begin increasing again as the firm continues to invest in its fiber network. We’ve also tempered our expectations for future cuts to capital spending to reflect the potential need to remove lead-sheathed cables from the network.
Economic Moat Rating
Wireless is AT&T’s most important business. Returns on capital here have eroded somewhat in recent years as the firm has spent heavily on wireless spectrum and invested to put it to use. We estimate the business produced a return on capital in 2022 of roughly 9%, or about 11% excluding goodwill, modestly above our estimate of the firm’s cost of capital. These figures are respectively down from about 10% and 12% in 2018. Over those five years, segment operating income is up 19% cumulatively while the invested capital base has expanded about 30%, primarily on $40 billion of spectrum purchases.
We expect that wireless returns will remain ahead of AT&T’s cost of capital. Verizon Communications VZ, AT&T, and T-Mobile dominate the U.S. wireless market, collectively claiming nearly 90% of retail postpaid and prepaid phone customers between them and supplying the network capacity to support most other players. Providing solid nationwide coverage requires heavy fixed investments in wireless spectrum and network infrastructure. While a larger customer base requires incremental investment in network capacity, a significant portion of costs are either fixed or more efficiently absorbed as network utilization reaches optimal levels in more locations.
With three sizable players, we don’t believe the carriers have an incentive to aggressively poach each other’s customers, given how painfully slow market share shifts occur in the business. Each of the three major carriers has pledged substantial capital returns to shareholders. AT&T’s dividend totals $8 billion annually, Verizon’s is $11 billion, and T-Mobile recently instituted a dividend and has said it can repurchase up to $60 billion of its shares through 2025. To support these returns, each of the carriers has guided investors to expect modest but steady revenue growth over the next several years. These actions indicate that none of the carriers is looking to radically disrupt the current pricing structure in the industry and that each will increase prices as needed to offset any cost pressures that emerge.
Risk and Uncertainty
Our Medium Uncertainty Rating reflects the volatility we expect AT&T investors will face relative to our global coverage. Regulation and technological change are the primary uncertainties facing AT&T. Wireless and broadband services are often considered necessary for social inclusion, in terms of employment and education. If AT&T’s services are deemed insufficient or overpriced, especially if in response to weak competition, regulators or politicians could step in. The firm is also still responsible for providing fixed-line phone services to millions of homes across the U.S., including many in small towns and rural areas. It could be compelled to invest more in rural markets even if economic returns are insufficient.
T Bulls Say
- Following a period of investment, AT&T will hold a nationwide 5G wireless network with deep spectrum behind it and a fiber network capable of reaching nearly one-fourth of the United States.
- AT&T has the scale to remain a strong wireless competitor over the long term. With three dominant carriers, industry pricing should be more rational going forward.
- Combining wireless and fixed-line networks with new technologies and deep expertise makes AT&T a force in enterprise services.
T Bears Say
- The cost of maintaining dominance in the wireless industry by controlling spectrum has been exceptionally high over the years. AT&T has spent $40 billion over the past three years for licenses with few prospects for incremental revenue.
- Advancing technology will eventually swamp AT&T’s wireless business, enabling a host of firms to enter the market, further commoditizing this service.
- AT&T’s massive debt load will catch up with it. The firm carries far higher leverage than it has historically, and its dividend payout remains high. Lead liabilities could be an additional burden.
This article was compiled by Quinn Rennell.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.