AT&T Inc. Is a Case of Bad Quarter, Good Stock

In a sea of companies that reported double beat and raise quarters, telecom giant AT&T Inc. (NYSE:T) threw up a goose egg with a double miss quarter.

In response, T stock dropped more than 7% Wednesday before rebounding slightly for a 5% loss overall.

Despite the big drop, there were things to like about the quarter. AT&T’s wireless business continues on with strong momentum. The company’s answer to cord cutting, DirecTV Now, continues to grow its customer base at a healthy rate.

But the cord-cutting headwind still weighs on operations and T stock. The company lost more linear TV and voice connections than anticipated, and that led to a drop in revenues, despite the strength in wireless and DirecTV Now.

Moreover, margins were pressured because the company’s growth segment (DirecTV Now) carries lower margins than its declining segment (linear TV).

In other words, AT&T’s first quarter earnings report was littered with red flags. But eventually, those red flags will go away as the company replaces its old, linear TV business with a new, internet TV business. The company’s margin profile may be lower, but revenues and operations will otherwise will be stable.

In the low $30’s, AT&T stock isn’t priced for stable. It is priced for continued erosion. Thus, now looks like a good time to buy the dip.

Here’s a deeper look:

Bad Quarter

Overall, AT&T’s quarter wasn’t that good. In fact, there is reason to call it bad, despite strength in wireless and DirecTV Now.

The wireless business did well. T reported 3.2 million wireless net adds, which is up from a year ago (2.7 million) and two years ago (2.3 million). The total wireless sub base grew 9% year-over-year, one of its strongest growth rates in recent memory. Postpaid phone churn hit a new first quarter low of 0.84%.

DirecTV Now also did well. T reported 312,000 net adds for DirecTV Now. Two years ago, DirecTV Now added 328,00 subs, so this growth business is clearly sustaining healthy subscriber growth trends. The total DirecTV Now subscriber base now stands at 1.5 million.

But robust strength in DirecTV Now wasn’t enough to offset continued linear TV losses. AT&T reported a 10% decline in the number of U-Verse connections and a 4% decline in the number of satellite connections. In grand total, even with strong DirecTV Now numbers, total video connections dropped 0.3% year-over-year.

That isn’t much. But it does show that DirecTV’s current strength isn’t enough to offset linear TV’s current weakness. That is bad news. If this trend persists, revenue growth and margins will fall back over the next several years.

Good Stock

Fortunately, I don’t think that trend will persist.

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My view on T is that the company’s growth segments (wireless build-out and DirecTV Now ramp) will eventually more than offset its declining segments (legacy voice and linear TV). This viewpoint is built on the thesis that internet entertainment services like DirecTV Now will go mainstream in the near future, and at that point, T’s entire cable business will be swapped out and replaced by an equally large over-the-top business powered by DirecTV Now.

Granted, the OTT business currently carries lower margins than the linear TV business. But that is a near-term problem. Eventually, at scale, the OTT business will leverage product and efficiency improvements to improve the margin profile to be on par with the linear TV business.

Thus, over the next several years, revenue growth should hug the flat-line while margins should be stable. T stock currently trades at less than 10-times next year’s earnings estimates and has a dividend yield of 6%.

In other words, T stock isn’t priced for operational stabilization. It is priced for operational deterioration. But stabilization is coming, and as such, T stock looks attractive in the lower $30’s.

Bottom Line on T Stock

When it comes to T stock, the good is good, and the bad is bad.

Eventually, the good will outweigh the bad as internet entertainment services go mainstream and offset traditional TV declines. T stock isn’t priced for this most likely outcome, making the stock an attractive asset to own in the lower $30’s.

As of this writing, Luke