AT&T Weathers the Storm Well; Shares Undervalued

While not immune to the COVID-19 outbreak, AT&T’s T first-quarter results demonstrate the overall resilience of the business. The firm estimated that direct costs related to COVID-19 totaled $430 million ($0.05 per share) during the quarter, including a $250 million increase in bad-debt reserves and increased pay for front-line employees. The net impact on profitability otherwise was not material, with several business impacts offsetting one another. Management withdrew its guidance for 2020 except to say that the dividend payout will likely be around 60% of free cash flow (versus 51% in 2019). Excess cash flow will now go to debt reduction rather than share repurchases, an outcome we believe is favorable for long-term investors. We don’t plan to change our $38 fair value estimate or narrow moat rating.

The wireless business, AT&T’s most important, posted solid customer metrics, with 163,000 net postpaid phone customer additions during the quarter, double a year ago. While AT&T stopped disconnecting customers for nonpayment in March, its reported figures exclude these accounts. Reported customer churn still declined year over year. Average revenue per customer also continued to trend gradually higher, driving wireless service revenue up 2.5% versus a year ago. Wireless equipment sales declined sharply, as customers unsurprisingly aren’t rushing out to buy phones or change carriers. Wireless costs dropped as a result, lifting the segment EBITDA margin 3 percentage points year over year to a record 45%.

WarnerMedia didn’t fare as well during the quarter. Turner ad revenue declined 24% on the loss of the NCAA men’s basketball tournament and other sports events while Warner Bros. movie sales dropped 27%. While lower sports rights costs cushioned the blow, investment to support the May launch of HBO Max offset most of this benefit. With total WarnerMedia revenue down 12% year over year, the segment EBITDA margin dipped to 25% from 29% a year ago.

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