AT&T Beats on Record Wireless

Before the opening bell, AT&T Inc. (T - Analyst Report), the second largest U.S. mobile service provider, reported second quarter 2012 adjusted earnings per share of 66 cents. The quarter’s earnings surpassed the Zacks Consensus Estimate by 3 cents and the year-ago earnings by 6 cents.

The company once again delivered an outstanding performance with double-digit earnings and operating income growth. The wireless segment performed strongly with record low churn rates and best-ever margins.

Revenue grew 0.3% year over year to $31.57 billion, but missed the Zacks Consensus Estimate of $31.74 billion. Excluding the impact of the sale of the Advertising Solutions unit, revenue increased 2% year over year.

Operating income increased 10.6% year over year to $6.8 billion in the second quarter. Operating margin expanded to a record 21.6% from 19.6% in the year-ago quarter. This represents the highest margins in four years.

Segment Results

Wireless revenue, including service and equipment, rose 4.8% year over year to $16.4 billion primarily on the back of robust smartphone and branded computing device sales as well as lower churn.

Wireless data revenue leaped 18.8% year over year to $6.4 billion, driven by Internet access, multimedia and text messages.

AT&T added 1.3 million wireless customers in the reported quarter, totaling 105.2 million. Strong additions were attributable to the continued adoption of smartphones, including Apple Inc.’s (AAPL - Analyst Report) iPhones and Google Inc.’s (GOOG - Analyst Report) Android based phones as well as increased sales of tablets and connected devices such as automobile monitoring systems and security systems.

Retail post-paid additions were 320,000, retail-prepaid additions were 92,000, connected device additions were 382,000 and reseller additions were 472,000 in the reported quarter. AT&T added 496,000 branded computing subscribers (including tablets, aircards, MiFi devices, tethering plans and other data-only devices), thus bringing the total to 6.3 million. The branded computing subscriber base grew 50% year over year.

The company sold 5.1 million smartphones in the reported quarter, of which 3.7 million were iPhones and the rest were Android and other smartphones. Notably, 22% of the iPhone customers were new to AT&T.

Total churn improved to a record low of 1.18% from 1.43% in the prior-year quarter and 1.47% in the prior quarter. Post-paid churn improved to 0.97% from 1.15% in the prior-year quarter and 1.10% in the prior quarter. This also represents the lowest level of churn in the company’s history.

Post-paid ARPU (average revenue per user) grew 1.7% year over year to a record $64.93, driven by healthy data growth.

Wireline revenues dipped 0.8% year over year to $14.9 billion. Strong data revenues driven by improving consumer and business strategic services revenue trends partly compensated for lower voice and other revenues.

Revenue from residential customers inched up 1.7% year over year (maximum growth in more than four years) to $5.5 billion, driven by AT&T U-verse services while business revenue slid 1.5% year over year to $9.1 billion, reflecting continued weakness in voice and legacy data products. Strategic business services such as Ethernet, Virtual Private Networks, hosting, IP conferencing and application services, spiked 13.5% year over year.

AT&T's total video subscribers, which include U-verse TV and bundled satellite customers, touched 5.8 million at the end of the second quarter. Total U-verse TV subscribers reached 4.1 million with the net addition of 155,000 customers on continued high-speed Internet attach rates.

Total consumer connections plunged to 40.2 million as of June 2012 from 42.5 million in the same month a year ago, due to a drop in traditional voice access lines, partially offset by higher video and broadband connections.

Cash Flow

AT&T generated $9.7 billion cash from operations in the reported quarter, up from $9.0 billion in the year-ago quarter. The company’s expenditure declined to $4.5 billion from $5.3 billion in the year-ago quarter. Free cash flow was $5.1 billion compared to $3.7 billion in the year-ago quarter.

The company repurchased 75.8 million of shares for $2.5 billion in the reported quarter. With this, AT&T has 156.5 million shares remaining in its buyback authorization, which started last quarter.

Our Take

We believe that strong adoption of smartphones, expansion of LTE networks and U-verse services, as well as the entry into cloud computing and hotel WiFi businesses will boost the company’s future profitability. Further, a healthy balance sheet and strong commitment to return value to shareholders in the form of dividends and share repurchases make the stock more attractive for income-oriented investors.

However, persistent declines in traditional voice access lines, aggressive pricing plans from its largest rivals Verizon Communications Inc. (VZ - Analyst Report) and Sprint Nextel Corp. (S - Analyst Report), iPhone subsidies and intense competition from cable companies and other alternative service providers are risks to the stock.

We are currently maintaining our long-term Neutral recommendation on AT&T. The stock retains a Zacks #3 (Hold) Rank for the short term (1–3 months).