(Note: This article originally appeared in the October 20, 2022 newsletter.)
The response to the AT&T (NYSE:T) market’s third-quarter report shows how overblown concerns were about the company’s future. Mr. Market tends to assume that a bad quarter will be followed by other bad quarters (especially with the history of this company). Then there is the additional part of the market that considers a stock to be bad if it goes down. The combination of these two groups and additional worries really made for a bargain tier stock for those who had the nerve to take advantage of the situation.
It takes a lot of volume for a slew of surprised big investors to make the kind of stock price move that happened on October 20, 2022. It just goes to show how many big investors were expecting the worst. So the surprise earnings announcement led to a complete reassessment of the future.
One of the things management pointed out on the conference call was that the capital budget was down. The initial budget had previously surprised the market combined with cash flow below expectations. So far, management is sticking to some of the original targets for next year despite market concerns about a recession. There will probably be more clarity in the year-end report.
This all goes to show how Mr. Market can be exaggerating in worrying about a reversal early in the process before the various statements have had a chance to clean up what caused the reversal in the first place. For individual investors who do a business of this magnitude, with the debt rating it has, it is very likely to recover. Therefore, there is a contrarian investment opportunity that will likely turn out to be very profitable.
Actions behind the numbers
Management pointed out that much of what the market will see actually started a few years ago. Turnarounds in large companies take time. So the initial moves may have been clouded by all the divestment news at the time.
Management probably tried several things before finding the “winning formula” because quite a few things were overlooked in the acquisition process. That meant the turnaround probably wasn’t noticeable for a while. The decision to focus the business on the remaining business (as well as deciding which remaining business to focus on) was made at the same time as the decision was made to divest the non-core business. The fact that it took so long to show results to shareholders shows the scale of the challenges the company faced when the new CEO took over.
The other thing management noted is that free cash flow should accelerate from here. This has allayed considerable concerns about the future of the dividend. When cash flow declined last quarter, the first thing that stood out was debt worries and dividend cuts. But it was really far too early to tell whether the cash flow problems were permanent or transitory. At present, it appears that the problems are transitory.
Free movement of capital
Free cash flow is the remaining concern that may resurface.
The reason is stated above. The market has long been concerned about the repayment of considerable indebtedness. The year-to-date numbers don’t really inspire confidence, although the quarterly numbers are pointing in the right direction.
Therefore, management must demonstrate that free cash flow will continue to grow not only to provide the right cushion for dividends noted above, but also to properly manage the debt balance. Obviously, Mr. Market wants a lower debt ratio and probably lower debt as well. But the good thing about an upside surprise is that the market will likely expect a continuation of the positive trend established above.
This should help keep the common stock price at a more reasonable level. Management noted that the business may grow a bit in the future. But until this is demonstrated for a few quarters, the market is likely to be on pins and needles.
This is often the reason why the beginning of a recovery story or cyclical recovery is volatile. The market has little or no confidence in the future as long as there is no history on which the market can rely. Expect Mr. Market to rock to extremes until there is a track record that the company will meet its new goals for what remains of the company.
Management expressed confidence in having the right formula to grow the wireless business. But the last quarter clearly caused a scare in the market and caused the share price to fall. Management admitted on the conference call that it had work to do to restore market confidence in its abilities.
Personally, I continue to believe that this title has a bright future from the post-spin-off price. So there is ground to “invent” plus potential upside potential. I also think there will be room to increase the dividend once the debt issues have been dealt with to the satisfaction of the market.
Management has paid off a good portion of the debt. But the management also received a good amount of money in the disposal transactions. From now on, the management must prove that the remaining business can be a good quality business with a good future. This quarter has erased a lot of worries in the markets. But these worries are likely to return with the slightest perceived stumble.
The main concern of the market would now be the effect of a possible recession on the activities of the company. Management considered the company to be recession-proof. This is yet another thing the market will want to demonstrate now that only core business remains.
Management has taken note of some joint venture agreements and is exploring growth ideas for the future. For now, the company has a lot to do. But it is clear that revenues and profits can grow from current levels to provide decent cash flow.
At the current yield, shareholders receive a dividend that represents a return just below what average investors earn over the long term. The stock price only needs an average return of about 1% or 2% to achieve that average return. Still, this stock offers the potential for a recovery of at least $20, and then likely room for growth beyond that. The risk with a company of this size is very low because the market has really assumed the worst for some time.
Mr. Market is only beginning to hope for a better future. It’s probably a very easy target for a management that started the turnaround story a few years ago.