AT&T: New cash pattern takes hold in next quarter (NYSE:T)

AT&T Inc. (New York Stock Exchange:T) has never received credit for the new cash flow pattern now that management has abandoned all non-core businesses. The last article noted how enthusiasm for the The cash flow results likely implied low expectations. That means the next quarter could well produce a further boost in the share price because cash flow should once again increase seasonally.

The business itself is in the midst of several transitions. There's 5G, which is being rolled out as quickly as possible. On the other hand, I just received a notice about the possible termination of my landline service. Of course, that also shows my age. Over time, the decline of “older” businesses will become less significant, while the growth of new businesses will remain more significant. That should result in slightly faster overall company growth. than at present. In the long term, this bodes well for increased cash flow.

The stock price has largely responded to the cash flow situation, as shown above. There could be a dip in the seasonally weak first quarter, but that is far enough away from the current situation that it should not yet have an effect on the stock price.

But if management continues to grow the overall business at a single-digit pace, then the direction of the stock price should be upwards over the long term. In the near term, the continued focus strategy should allow both EBITDA and free cash flow to grow faster than the business over the first few years.

Debt

There have been some concerns about debt levels.

Based on the commentsWhat worries me most is that the debt is not being paid down quickly enough, but we also need to transition the business to 5G and of course grow the mobile business or any other wireless business.

There is always some risk of defaulting on debt, as the company can get caught up in the “high-tech merry-go-round,” where continuous improvements result in cash flow generated by operations always being invested in the latest technological upgrade. This, of course, impacts future free cash flow to the point that debts are never paid.

However, business growth should indicate that there will be more free cash flow in the future, even if the percentage of cash from operations that is converted into free cash flow is lower. The fact that the debt ratio is now below 3 should indicate that steps are being taken in that direction “just in case.”

Furthermore, despite the long wait, there has been a debt repayment shown above, which is admittedly a small debt reduction, but still has to be a step in the right direction, even if progress in that direction is painfully slow for shareholders.

Growth

Meanwhile, companies that are projected to grow are growing. What needs to happen is that the contraction of traditional companies becomes less significant so that growth companies predominate. To some extent, the combination of focusing on the business and the growth that is about to be shown has resulted in low single-digit growth. What should happen going forward is that the areas of growth going forward become the growth of the business as a whole.

This business (and mobile phones) typically have a fairly heavy fourth quarter. It is typically the basis for a lot of free cash flow in the quarter. Much of what is sold in the fourth quarter causes a seasonal spike in accounts payable that reverses in the first quarter of the following fiscal year. It should be noted that the company is tracking people who do this in addition to mobile phones.

The only risk is that this business becomes generic and the company runs out of new, more expensive “toys” that consumers can afford in the future. Right now, that seems unlikely, but it is a normal prediction of the business cycle that this business will become generic in the future and possibly be replaced by some new technology that we currently have no idea about.

This is shown below because there is a good chance that the previous decline will be the future driver of growth in this area. In fact, it may be the differentiating factor when it comes to competing services, as bundling may be the important part for consumers (cost savings).

The question is always the challenge of keeping subscribers.

Probably the main idea here is that management has successfully transitioned a landline company to the latest technology. It was a disaster and there are many mistakes to point out. Most transitions are like this, unfortunately. It's one reason why few companies survive to the “next generation.”

In the business world, the goal is probably to do more things right than wrong. Here, “right” seems to be prevailing. In the case of AT&T, the business side of the company still seems to be transitioning from cable services to a cellular phone system. The transition still seems to predominate (as opposed to new product growth).

Summary

As demonstrated by the second quarter share price reaction to the cash flow news, the market has very low expectations for this company. That could well mean that price performance will remain relatively strong in a very tired bull market that is now focused on a few stocks. Once a stock market correction begins, this company has the advantage of a concentration strategy and new growth areas that will be well on track.

This company remains a good buy as the future looks like it will bring a lot of good news. One potential period of weakness going forward looks to be the first quarter, when there are a lot of one-time payments for the fiscal year that decimate free cash flow on a seasonal basis. That may be something traders can take advantage of.

But for income-seeking investors, it now appears that the dividend will not only be maintained, but will slowly grow in the future. An earlier slide shows a dividend yield that accounts for most of the total return that many investors report over the long term. As a result, the stock price only has to appreciate a small amount for investors to get that average annual return that many report over the long term.

It remains a good buy as it should grow in the upper single digits to possibly 10% annually, averaging around 7% annually combined with the current dividend yield of over 5%. The current P/E ratio of 9 could easily expand to 13 or 15 in a scenario like that as well.

The continued turnaround seems to indicate that this investment-grade opportunity will offer a compounded return of around 15% for at least the next five years. At least in the near term, both cash flow from operating activities (the GAAP figure) and free cash flow should grow faster than revenue as the company continues to focus on its remaining core businesses to become “lean and lean.”

Risks

The biggest risk is likely to be a sustained period of high inflation that increases the cost of servicing debt. Added to this would be the company’s inability to recover the costs that would allow results to keep up with that high inflation. Right now, that appears to be a remote possibility. But a key step toward achieving that prospect will be how the expiring parts of the tax cut are handled in 2025, along with what is done to reduce the ongoing federal deficit.

There is always the risk that a new technology will render the company's business completely obsolete. The last time this happened, when mobile phones came out, management made more right decisions than wrong ones to enable the company to recover from the decline of the landline business. Although investors cannot imagine what that future will look like, it could still happen.

The loss of key personnel could delay the company's recovery path.

As far as valuation goes, it should be noted that valuation is highly dependent on market conditions when we get to that point. So while I can estimate a future valuation using current market conditions, there is no guarantee that those conditions will hold five years from now. What I think I can say with confidence is that the ongoing turnaround is becoming apparent to the market such that the positive quarterly comparisons (likely) ahead should allow this issue to outperform a significant portion of the market because the current price-to-earnings ratio is well below the market average and should indicate low (or no) expectations.