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January 28, 2009

Good Quarter But Confusing and Lower Gudiance Muddies the Water

Immediately below are two comments on AT&T's 4Q08 earnings report. The first one is my immediate reaction writtne prior to the conference call. The second one is my summary of the call. Overall, I would have liked better 2009 guidance but I think the stock offers upside while providing downside protection given the large dividend, stable cash flow, and good balance sheet.

T: Good Quarter, Confusing (Weak?) Guidance
1/28/2009 9:28 AM EST
AT&T's 4Q looks fine. A bit light but key misses from VZ on sub growth and wireless margins were not repeated. the stock initially traded up but is now about 2% lower. Guidance seems to be the issue.

In 2008, T reported EPS of $2.16 but announced adjusted EPS of $2.81 excluding merger related costs of 49 cents, merger related trust investment losses of 9 cents, and severance charges of 11 cents.

The company states that in 2009 it will no longer report adjusted EPS as merger integration is largely complete. The company then states that 2009 "reported" consolidated earnings and margins are expected to be stable excluding 19 cents in pension expense (no additional pension funding).

If reported 2008 EPS were $2.16 and they will be stable less the 19 cents, that implies reported 2009 guidance of less than $2.00. This seems to be below consensus. Consensus is hard to understand because some of it includes severance, amortization, and pension and some does not.

Clarity on this issue on the conference call will dictate the stock. If EPS are $2.00 then the multiple is a couple of points higher than I thought. I still think T would have limited downside but for the short-term at least the stock would in the penalty box, especially after the mixed report from Verizon yesterday was taken as a negative.

Conference Call Summary
1/28/2009 1:25 PM EST

AT&T reported solid 4Q08 results. Headline numbers barely missed consensus but the underlying growth drivers met or exceeded estimates. EPS came in at 64 cents on revenues of $31.1 billion compared to consensus of 65 cents and $31.3 billion.

Based solely on the quarter, the stock would be trading up but 2009 guidance appears to be 10-20 cents below expectations. The numbers are confusing as T will no longer announce adjusted EPS. Guidance is for "stable earnings" less 19 cents in non-cash pension expense. Reported 2008 EPS were $2.16. Adjusted EPS in 2008 were $2.81 but exclude 50 cents in amortization of customer lists and other one-time items.

For 2009, amortization will be 40 cents and there will be other one-time items but management only classified them as "contingencies" without specifying a specific amount. If we assume it might be 10 cents then 2009 guidance looks like $2.47 (2.16-.19+50). This is the figure for comparison to analyst estimates.

Analyst estimates are $2.74 but I think some of them have yet to include the higher pension expense so let's call it $2.65. If my $2.47 assumption is accurate, then the guidance is about 7% below consensus.

In the near-term this is clear negative for the stock but is possible that by resetting the EPS level T has cleared the books for 2009 and no longer faces risk of further estimates cuts....

....This idea gains support given trends in growth businesses in 4Q08. Wireless subscriber additions matched expectations, wireless margins exceeded expectations as the benefit from iPhone and other high ARPU smartphone subscriptions is starting to bite, and U-verse TV and broadband subscriptions and revenue exceeded expectations.

These trends will need to stay in place because wireline revenues and margins were below expectations in 4Q08 and given better than expected margin guidance in 2009 for wireless the implication is that that wireline (and advertising/publishing) are facing a very tough year. Consumer wireline is not in bad shape but Enterprise revenues fell 4% in 4Q, much worse than estimates.

The question for investors is whether T has reset the bar low enough for 2009 such that better than expected trends in growth drivers can lead to positive surprises. Given the stiff macroeconomic headwinds it is hard to answer affirmatively but this is where the upside now lies in the shares. It is a bet I am willing to make especially since I am paid to wait with a 6% dividend yield, stable cash flow, and a strong balance sheet.

Posted by Steve Birenberg at January 28, 2009 01:24 PM in Telephone