In response to solid 2Q09 earnings, AT&T shares are breaking out of a multi-month funk where they sharply lagged the market and peer Verizon. The results were at the high end of expectations and contained no major negative surprises. The stage is set for a better second half and 2010 as the economy stabilizes and improves and iPhone dilution wanes. The shares have been disappointing since I purchased them for Northlake clients late last year but I remain confident the stock can work its way to the low $30s in the next 6 to 9 months. Combine with a 6.7% dividend the total return potential is good. I also think this quarter provides a floor on the stock where it should hold up better than the market in the event recent market gains reverse.
The big news in the quarter was the continued positive impact of AT&T’s exclusive iPhone deal. Wireless subscriber growth exceeded expectations and despite the downward pressure this places on margins due to phone subsidies, profitability held up better than expected. Strong growth in data revenues and low churn strongly suggest that as iPhone activations plateau, AT&T’s profits in wireless will spike higher. This sets the stage for a resumption of earnings growth in 2010.
Another positive in the quarter was signs that the steady deterioration in consumer wireline was stabilizing. Make no mistake, this business is in a long-term state of decline but access line losses were not quite as bad as feared. Couple this with growth in U-Verse TV and broadband and the shrinking mix of consumer wireline and the drag on overall growth is lessening.
The one negative in the quarter was that Enterprise revenues dropped more than expected. Along with fears of iPhone dilution, Enterprise had been the big factor causing the stock to lag. There really is no good news here and won’t be until the economy picks up and corporate spending reins are loosened.
The balance sheet and cash flow look a bit better than expected as capital spending was light in the quarter. The first half spending pace is below guidance but that could be a timing difference.
Overall, AT&T reported a solid quarter that revealed better times ahead. The stock is bouncing off recently depressed levels. I think there is more upside to come as investor psychology on AT&T shifts to better growth in 2010 and beyond as wireless becomes the dominant factor and the economy improves.
The big risk in the stock is the cost of maintaining the exclusive iPhone relationship. Apple is in a very strong bargaining position given the huge popularity of the iPhone and ongoing complaints about AT&T’s network quality. I think this likely to be a 2010 worry more than 2009 but it definitely places downward pressure on AT&T’s valuation all else equal.
Disclosure: AT&T and Apple are widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts.