AT&T was walloped this week. Should telecom investors be worried?

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After AT&T Inc. T-N reported its first-quarter financial results this week, any investor holding a telecom stock may have been left with an eerie feeling: Is the sector feeling the effects of a slowing economy?

Telecom stocks should be relatively safe bets. In good times and bad, consumers tend to keep their phones and other connections, offering a stable source of revenue to back attractive quarterly dividends.

But after AT&T’s share price fell 10.4 per cent on Thursday, its steepest one-day sell-off since the dot-com meltdown in 2000, telecom stocks suddenly looked vulnerable to the challenges weighing on other economically sensitive areas of the market.

Many of the numbers in AT&T’s quarterly report hardly looked like a reason to dump the stock.

Revenue edged up 1.4 per cent, compared with the same period a year ago, boosted by new wireless subscribers. Operating expenses were stable and adjusted operating income rose to US$6-billion, up slightly from US$5.8-billion last year.

The problem area? Free cash flow – cash generated by operating activities after expenses, which analysts believe is a good gauge of a telecom company’s ability to fund growth, reduce debt and raise dividends – fell 64 per cent, year-over-year, to US$1-billion.

John Stankey, AT&T’s chief executive officer, defended the decline during a call with analysts on Thursday, arguing that the result was in line with previous guidance.

“We said that the first quarter was going to be the low-water mark for free cash flow for several reasons,” Mr. Stankey said.

The first quarter is when the company pays for devices consumers bought during holiday sales at the end of 2022, he said, and when it spends on incentive compensation for executives. He reinforced his expectation for delivering full-year free cash flow of US$16-billion or better.

Still, the first-quarter result “certainly puts pressure on execution for the rest of the year,” Doug Mitchelson, an analyst at Credit Suisse, said in a note.

Although AT&T’s share price rebounded 3.2 per cent on Friday, this week’s volatility suggests that investors are on edge as other telecom companies prepare to release their own quarterly results over the next couple of weeks.

The shares of Verizon Communications Inc. and T-Mobile US Inc. fell on Thursday after AT&T’s quarterly report, suggesting that investors are lumping companies together instinctively amid simmering concerns over how consumers are responding to high inflation.

Verizon will report its results on April 25, followed by T-Mobile on April 27. Among Canadian players, BCE Inc. and Telus Corp. will report their first-quarter results on May 4.

Though Canadian telecom stocks held up during Thursday’s downturn, and operate within a different competitive and regulatory environment, they share several similarities with their U.S. counterparts.

Investors appreciate the sector for its stability and dividends, and look for growth in the number of wireless subscribers. Canadian companies are also facing consumers and businesses struggling with stubbornly high inflation and rising borrowing costs, potentially weighing on subscriber growth.

The good news here is that AT&T’s net postpaid phone subscribers – who pay their bills at the end of each month – increased by 424,000 in the first quarter. That was in line with analysts’ expectations and may be providing support to Canadian telecom stocks that tend to trade on this key metric.

But AT&T also suggested that demand for wireless subscriptions is moderating. Some cash-strapped consumers may be putting off product upgrades longer than usual, according to Mr. Stankey, providing an indication that telecom companies can be affected by shifting economic currents.

“That may not mean we should expect an immediate slowdown in Canada, since penetration remains well below that of the U.S.,” Jerome Dubreuil, an analyst at Desjardins Securities, said in an e-mail.

“But it still clouds the outlook to some extent,” Mr. Dubreuil said.

This uncertainty follows a period when Canadian telecom stocks have been outperforming U.S. telecom stocks by a wide margin. BCE and Telus have risen about 9 per cent this year, on average, while AT&T and Verizon are down by an average of about 3 per cent in 2023 after this week’s sell-off.

That’s a substantial 12 percentage-point difference, which may support investor confidence in the Canadian telecom sector as a solid bet – or point to a potential downturn should anxiety over AT&T’s quarterly results spread further.

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