(T) AT&T Outshines on iPhones

AT&T Inc. (T), the second largest mobile service provider in the U.S., reported first quarter 2012 adjusted earnings of 60 cents per share, surpassing both the Zacks Consensus Estimate and the year-ago earnings by 3 cents.

The company made a strong start to the year, with mid-single-digit growth in operating income and earnings. Lower sales of Apple Inc.’s (AAPL) iPhone during the quarter helped it to cut expenses that resulted in more profits but hurt subscriber growth to some extent. Further, the out performance was attributable to the healthy wireless and wireline businesses.

Revenue grew 1.8% year over year to $31.82 billion, outpacing the Zacks Consensus Estimate of $31.81 billion. Improved performance in the quarter was mainly driven by continued 4G mobile broadband sales, strong wireless network performance and improved wireline revenue trends.

Operating income increased 5% year over year to $6.1 billion in the first quarter.

Segment Results

Wireless revenue, including service and equipment, rose 5.4% year over year to $16.1 billion, primarily on the back of robust smartphone and branded computing device sales as well as lower post-paid churn.

Wireless data revenue leaped 19.9% year over year to $6.1 billion, driven by Internet access, multimedia and text messages.

AT&T added 726,000 wireless customers in the reported quarter totaling 103.9 million. Strong additions were attributable to the rapid adoption of smartphones including iPhones and Google Inc.’s (GOOG) Androids along with growth in tablets and connected devices such as automobile monitoring systems and security systems.

Retail post-paid additions were 187,000, retail-prepaid additions were 125,000, connected device additions were 230,000 and reseller additions were 184,000 in the reported quarter. AT&T added 460,000 branded computing subscribers (including tablets, aircards, MiFi devices, tethering plans and other data-only devices), thus bringing the total to 5.8 million. The branded computing subscriber total shot up 70% year over year and represented the best-ever first quarter in the company’s history.

The company sold 5.5 million smartphones in the reported quarter, exceeding the year-ago record. About 30% of the smartphones were 4G enabled devices. Out of the total smartphones sold, 4.3 million were iPhones and the rest were Android and other smartphones. Notably, 21% of the iPhone customers were new to AT&T.

Total churn (customer switch) increased to 1.47% in the first quarter from 1.36% in the prior-year quarter and 1.39% in the prior quarter. Post-paid churn improved to 1.10% from 1.18% in the prior-year quarter and 1.21% in the prior quarter. This marks the lowest level of churn in seven quarters.

Post-paid ARPU (average revenue per user) grew 1.7% year over year to $64.46, 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 offset lower voice and other revenues.

Revenue from residential customers inched up 1% year over year to $5.4 billion, driven by AT&T U-verse services while business revenue slid 0.8% year over year to $9.2 billion, reflecting economic weakness in voice and legacy data products. Strategic business services such as Ethernet, Virtual Private Networks, hosting, IP conferencing and application services spiked 19% year over year.

AT&T’s total video subscribers, which include U-verse TV and bundled satellite customers, touched 5.7 million at the end of the first quarter. Total U-verse TV subscribers reached 4 million with the net addition of 200,000 customers on continued high-speed Internet attach rates.

Total consumer connections plunged to 40.8 million as of March 2012 from 43.1 million in the same month a year ago, due to a drop in traditional voice access lines, partially offset by higher U-verse TV and VoIP (Voice over Internet Protocol) connections.

Cash Flow

AT&T generated $7.8 billion cash from operations in the reported quarter, up from $7.7 billion in the year-ago quarter. The company’s expenditure increased slightly to $4.3 billion from $4.2 billion. Free cash flow was $3.5 billion compared to $3.6 billion in the year-ago quarter.

The company repurchased 67.7 million of shares for $2.1 billion in the reported quarter. AT&T has a 300 million share buyback authorization, which it started in the quarter.

Our Take

We expect this year to be strong with continued growth in revenue, earnings per share and free cash flow as well as margin expansion. Strong adoption of iPhones and Android smartphone sales coupled with the LTE networks, expanding U-verse services, entrance into cloud computing and hotel WiFi businesses are expected to boost the company’s future profitability.

However, persistent declines in traditional voice access lines, aggressive pricing plans by rivals Verizon Communication Inc. (VZ) and Sprint Nextel Corp. (S), iPhone subsidies and intense competition from cable companies and other alternative services 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).

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