AT&T Earnings: Wireless Customer Gains and Margin Expansion Continue to Drive Cash Flow

Key Morningstar Metrics for AT&T

• Fair Value Estimate: $23.00
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

What We Thought of AT&T’s Earnings

AT&T’s T wireless network outage earlier this year and its data breach during the second quarter had no discernible impact on wireless customer growth. Profitability also continued to improve across most of the business, and free cash flow generation was solid. We are maintaining our $23 fair value estimate and believe the shares are undervalued.

Wireless customer retention remains excellent, as postpaid phone churn (the pace of customer defections) dropped to the lowest level in three years. AT&T again struggled a bit to attract new customers, at least relative to Verizon Communications VZ, but the churn improvement lifted net postpaid phone customer additions to 419,000 during the quarter, up from 326,000 a year ago and well ahead of Verizon.

Revenue per postpaid wireless phone customer increased 1.4% compared with the prior year, lifting wireless service revenue by 3.4% during the quarter, at the high end of management’s forecast for the year, which remains in the 3% range. The wireless segment EBITDA margin expanded 2 percentage points versus a year ago, to 45%.

The consumer fixed-line segment increased revenue by 3%, adding 239,000 net fiber broadband customers during the quarter. Segment EBITDA increased nearly 7% year over year. Management indicated that nearly 40% of fiber broadband customers subscribe to its wireless service. AT&T also claims that its wireless market share is 5 percentage points higher within its fiber footprint than its national average. The firm expects to lay out additional plans to expand fiber availability, directly or through partnerships, later this year as debt leverage falls toward its longer-term target of 2.5 times EBITDA. We agree that AT&T has a unique opportunity to extend its ability to provide both services in more places, leveraging its large wireless customer base. Highlighting the opportunity, only about 12%-13% of Comcast CMCSA and Charter Communications’ CHTR broadband customers take their wireless offerings, which use the Verizon network for coverage.