AT&T Inc. (NYSE:T) just reported its Q1 earnings as covered by Seeking Alpha here. On what looks like a good day for the market, it’s no surprise the stock is going up pre-market (although that could change in no time) as the company beat on EPS and revenue. This quarter also marks the debut of the new AT&T, which is an irony because the company has actually gone back to being the old AT&T instead of trying to be the jack-of-all-trades.

We’re used to analyzing AT&T’s FCF before and after earnings, as shown in this article after Q4 2021 results. But why FCF, you may ask?

Why Cash Flow Above EPS

When evaluating dividend coverage, most investors and analysts tend to look at earnings per share (EPS). We prefer free cash flow as the best indicator of financial health for the following reasons:

• Profits tend to go up and down based on rare events and write-offs.
• Earnings are more subject to GAAP fluctuations.
• Cash flow is king.

While we understand this quarter wasn’t exactly the first full quarter for the new AT&T, the company’s reported numbers are still adjusted for the standalone company.

• Total outstanding shares: 7.2 billion
• Current quarterly dividend per share: $0.2775
• Quarterly FCF required to cover dividends: $1.998 billion
• Q1 FCF: $2.9 billion (According to the company’s website, “AT&T’s self-sustaining free cash flow was $2.9 billion¹⁶ for the quarter compared to $3.8 billion a year ago.”)
• Payout ratio using FCF: 68% ($1.998 billion divided by $2.9 billion)
• Reported EPS: 63 cents (AT&T standalone)
• Payout ratio using EPS: 44% ($0.2775 divided by $0.63)

(Source: YCharts.com)

What do we look like?

Clearly, the payout ratios show that the new dividend is not only safe, but has room for larger increases than the old AT&T of the recent past, where the dividend growth rate hovered between 1 % and 2%. Again, these are the early days, but it’s still worth keeping an eye on early on, especially given the company’s past behavior with respect to its balance sheet. We will add these numbers once the company reports earnings over the next 3 quarters to get a full year overview in a cumulative view.

Coming back to this quarter’s results, the main highlights are as follows:

• Mobility showed reasonably strong growth with postpaid churn below expectations of 0.79%, 700,000 postpaid phone net additions and 113,000 prepaid net additions. This translated into an impressive revenue increase of 5.5%.
• Business wireline revenues declined as expected, but the company said this was more than offset by growing demand in mobility and consumer wireline services.
• From a capital allocation perspective, the company is continuing its aggressive bet on 5G growth, with $24 billion in capital investment planned in 2022 and 2023. The $8 billion allocated to dividends this year are sufficient to meet the current annual obligation of $1.11 per share. With the debt situation being resolved and investments in 5G, we’re optimistic about dividend growth going forward, but for now, a 5.70% yield is big enough, even in this period of inflation.

Summarizing the quarter and current forward guidance, we quote the CEO from the earnings release:

“Our results, including free cash flow, are in line with our expectations of achieving the full-year guidance provided at our recent analyst day,” Stankey said in the release.

Conclusion

We continue to own AT&T and Warner Bros. Discovery, Inc. (WBD) at the moment, but AT&T is one shot away from being out of the portfolio. As we’ve mentioned in previous articles, if the company again shows signs of “running down” or unreasonably takes on more debt, that’s probably it for us.

Also, speaking of WBD, the sale of streaming companies by Netflix (NFLX) has reduced WBD enough that we are considering adding to our WBD position. Buried in AT&T’s earnings release, this statement shows the strength of HBO Max over the same period that Netflix lost 200,000 subscribers: “Total number of HBO Max and HBO subscribers worldwide⁶ 76.8 million, up 12.8 million year-on-year; national subscribers⁷ of 48.6 million, up 4.4 million year-on-year.“

To conclude, AT&T remains a hold, and WBD offers a great buying opportunity.