AT&T's Stellar Developments

Few firms are as interesting to analyze in the current environment as telecommunications and entertainment giant AT&T (NYSE:T). Not only do you have the impact associated with the current COVID-19 pandemic affecting the firm, as it is affecting other firms as well, but you also have a conglomerate that the sum of both good parts and bad parts. These are individual businesses, and they really do fit mostly into two different categories: the ones that are robust growth machines for AT&T and its shareholders, and ones that are already in a steady state of permanent decline. Fortunately, for shareholders, what we saw during this latest quarter's release was the good side of the firm win out. And by a large margin at that. Strong cash flows, continued progress on developing its growth-oriented enterprises, and management's push to lower debt (however slowly) are all having a positive impact on the business.

A slew of good news

By most accounts, the latest quarter for AT&T was an upbeat one. For starters, let's begin with one of my favorite pieces of the business: its Connected Devices operations. Connected Devices, as I have written about before, are a play on the firm's 5G business and on the entire IoT (Internet of Things) societal shift. This underappreciated subsegment of the firm has done phenomenally well in recent years. Consider, though, its recent performance. In the third quarter this year, Connected Devices reported 75.967 million subscribers. This is up 22% from the 62.288 million subscribers reported the same quarter last year. It's also up 5.9%, or 4.205 million subscribers compared to the 71.762 million subscribers seen in the second quarter this year. To put this performance in perspective, consider that this quarter-over-quarter growth nominally was nearly double the 2.255 million net adds the company saw from the first quarter this year through the second quarter.

In some other areas, AT&T fared quite well. First, we have the issue of debt. Net debt during the quarter came in at $149.12 billion. This is down $2.90 billion from the $152.02 billion the company had on its books as of the end of its second quarter this year. Though this progress may not seem like much, it ignores some activities the company has engaged in. In particular, we have the firm's sale of its stake in Central European Media Enterprises, which should bring in about $1.1 billion in cash. It will also reduce the firm's exposure to the entity's debt by $575 million. All of this occurred after the end of the third quarter, so it should further reduce net debt.

Another area where AT&T is thriving relates to its wireless and fiber broadband operations. During the quarter, the company saw 645 thousand net additions to its wireless operations. On the whole, broadband really did suffer in the third quarter, with a decrease in subscribers of 1.4% year over year. The fiber broadband piece of this, however, is up 26.6% over the same period of time. From just one quarter ago, the number of fiber users grew by 357 thousand on a net basis.

Investors in AT&T are also sure to be interested in the progress being made by the firm's newest streaming service: HBO Max. Total subscribers to both HBO and HBO Max in the US totaled 38 million in the third quarter. This is up from 36 million a quarter earlier. Globally, these services have 57 million subscribers. For HBO Max specifically, management boasted a more than doubling in activations to 8.6 million. This compares favorably to 4.1 million one quarter earlier.

The last great positive we should touch on is the company's cash flow outlook. For months now, management had been forecasting a dividend payout ratio in the 60% range. At best, this was indicating free cash flow for the year of $24.9 billion, down from $29 billion last year. Now, due to strong performance, the picture has changed. During the third quarter, AT&T generated $12.1 billion in operating cash flow. This was up from $11.4 billion the same time last year. Capex of $3.9 billion resulted in free cash flow for the quarter totaling nearly $8.3 billion. By comparison, in the third quarter of its 2019 fiscal year, the company generated just $6.20 billion in free cash flow.

This robust performance had led management to increase its expectations to the point where free cash flow should be at least $26 billion for the year, if not higher. With a market cap as of this writing of $190.4 billion, shares of the business are trading at a price/free cash flow multiple of just 7.3. This is further underscored by the nearly 7.4% yield assigned to it by the market. Even if you throw net debt into the equation, AT&T's EV/free cash flow multiple is an attractive 13 moving forward. For the cash cow that the business has proven itself to be, that's quite a low multiple.

This is not all to say that there aren't bad things regarding AT&T. Plenty of legacy parts of the business showed continued deterioration during the quarter. Its Entertainment Group, for instance, saw revenue drop 10.2% year over year, declining from $11.20 billion to $10.05 billion. This was led by a 12.2% decline in its Video Entertainment operations. The number of total video connections for the company dropped 17.5% year over year, while voice connections dropped 14.8% over the same period of time. WarnerMedia was also slammed, with revenue declining 10% from $8.35 billion last year to $7.51 billion today. Though operating cash flow in the latest quarter was stronger than it was in the third quarter of 2019, year-to-date operating cash flow is weaker at $33.05 billion compared to 2019's $36.73 billion. Free cash flow is only similar due to a reduction in capex this year.

Takeaway

On the whole, the picture facing AT&T is looking really, really great. Stellar, even. The massive conglomerate really shocked investors, especially when it came to its forecast for stronger cash flow this year compared to prior expectations. The parts of the business focused on tomorrow appear to be flourishing and that is helping to offset permanent declines elsewhere. The fact that this is happening despite a hit caused by the pandemic (a hit equivalent to $0.21 per share when it comes to earnings) is even more impressive. In all, investors should be ecstatic regarding AT&T's figures and they should not hesitate to applaud the company accordingly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.