AT&T: Don't Lose Sight Of The Prize

AT&T Inc. (NYSE:T) investors likely breathed a sigh of relief since its second-quarter or FQ2 earnings release in late July. The public fallout over the lead-sheathed cables has calmed down somewhat, even as the authorities conducted their inquiries into the case.

Management pushed back against market pessimism against the challenges, highlighting that testing from "independent experts and established science indicate no significant public health risk from lead-clad cables." Furthermore, the company reminded investors that the "lead-clad cables constitute a small portion of the network."

As such, I assessed that the capitulation in mid-July leading to a bullish reversal has continued to hold firmly. Despite that, a lack of sustained buying momentum suggests buyers are likely holding back from adding aggressively. The company still faces significant free cash flow or FCF uncertainties surrounding its broadband and wireless strategies as it continues to build out its infrastructure.

Therefore, even though management communicated its confidence in achieving its full-year FY23 FCF guidance of $16B, the market is likely pricing in higher execution risks.

Recent results by cable leaders Comcast (CMCSA) and Charter (CHTR) have been constructive. Wolfe Research even opined in a recent note that the "competitive threat posed by fixed-wireless services is diminishing." The outperformance of CMCSA against T since October 2022 suggests the market has likely priced in more confident competitive dynamics by the leading cable players. It's also important to note that CMCSA has outperformed T over the past ten years. However, the recent outperformance suggests that investors rotated rapidly into CMCSA, which could lead to a sharp pullback against T subsequently.

Despite that, I have yet to glean such a downward reversal signal on CMCSA, suggesting sentiments still favor CMCSA against T. However, I believe market skepticism against AT&T is justified, given the challenges in executing its $11B FCF outlook for the second half of 2023. Based on its FY23 guidance, the company achieved about $5B in the first half, weighed down by its disappointing Q1 FCF delivery of $1B. While AT&T outperformed with a solid $4.2B FCF delivery in the second quarter, the company must post a significant result in Q4. Analyst estimates suggest that AT&T could post an FCF of $5B in Q3 and $6.3B in Q4.

However, achieving that skewed Q4 outcome against the current macroeconomic conditions could prove challenging. With interest rates expected to remain high, the company needs to juggle between its capital allocation priorities of paying down debt and dividends. However, the company's guidepost on both priorities has not shifted, so Bulls could argue that the company has likely baked in the challenges.

Hence, all eyes will likely be on the handsets upgrade cycle in Q4. Apple's (AAPL) previous FY23 85M shipment guidance to its supply chain partners suggests that investors must be prepared for stronger-than-anticipated headwinds. As such, I believe the market is likely assessing AT&T's delivery for Q3 before ascertaining whether the company could meet its full-year outlook.

Despite that, I believe it's also critical for investors to note that T's buying sentiment is still considered constructive, although not as robust as I had anticipated, despite the capitulation in July. Coupled with an "A-" valuation grade assigned by Seeking Alpha's Quant, T isn't aggressively configured.

As such, I'm ready to maintain my bullish thesis on T at the current levels, although my relative conviction level in T has moved lower. The main reason is I see other more attractive opportunities in the market to capitalize on, given the recent market pullback.

Rating: Downgraded to Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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