T-Mobile US (TMUS) Upgraded To Ba2 By Moody's, Outlook Stable

T-Mobile US Inc’s (NYSE:T) rating was recently upgraded to Ba2 (in certain metrics) by credit rating agency Moody's Investors Service (also known as Moody’s). Moreover, the company’s rating outlook has been confirmed stable.

Currently, T-Mobile US carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Moody's upgraded T-Mobile US' corporate family rating (CFR) to Ba2 from Ba3. The company’s probability of default rating was upgraded to Ba2-PD from Ba3-PD, its senior secured rating to Baa2 from Baa3 and its senior unsecured rating to Ba2 from Ba3. The Speculative Grade Liquidity Rating (SGL-1) was affirmed.

Why the Elevation?

T-Mobile US' innovative network expansion methodologies and improvement plans, stellar network performance, deployment of LTE-U technology and offering of attractive unlimited data are key factors behind the upgraded ratings. This is further supported by improving scale, healthy free cash flow generation, strong liquidity and valuable spectrum assets that also provide credit support. These positives are, however, offset by the company's third position in the domestic wireless industry.

The elevation also follows the decision of T-Mobile US and Sprint Corp (NYSE:S) to call off a potential merger. The merger could have pressurized T-Mobile US’ credit metrics, on materialization

The SGL-1 speculative grade liquidity rating justifies the company’s healthy liquidity position. Notably, in the third quarter of 2017, T-Mobile US generated $2,362 million of cash from operations compared with $1,740 million in the prior-year quarter. Free cash flow in the reported quarter was $921 million, up from $581 million in the year-ago quarter. As of Sep 30, the company had $739 million of cash and cash equivalents and $15,144 million of debt outstanding compared with $5,500 million and $22,186 million, respectively, at the end of 2016. The debt-to-capitalization ratio was 0.42 compared with 0.54 at the end of 2016. We believe that the company’s improved liquidity has strengthened Moody's expectation.

The stable outlook reflects T-Mobile US’ strong fundamentals, growth and improving credit metrics. This was balanced by management's leverage tolerance as indicated by its target capital structure.

Moody's Anticipation

Moody's expects T-Mobile US to generate healthy free cash flow in the next few years. It believes that the company is operating below its stated target leverage range. Moody's also expects the company’s credit metrics to remain stable, despite the highly competitive domestic wireless environment. This will be driven by continued postpaid phone subscriber growth, effective marketing schemes and improved cost management. T-Mobile US’ organic EBITDA growth is expected to remain strong.

Bottom line

Accumulating debt and declining cash flows can severely affect a company’s margins and credit ratings. Impressive operating metrics, and cash and liquidity structure in the third quarter of 2017 uplifted T-Mobile US.

We believe that T-Mobile US’ ratings could have been better, had the company’s financial policy been changed to reflect lower leverage tolerance.

However, if the company fails to generate more cash flows and reduce debt, ratings can deteriorate. Henceforth, T-Mobile US should ensure that EBITDA margins are not subject to sustained pressure. Moreover, the company’s future debt-funded share repurchases should not exceed its expectations.

Price Performance

Despite such positives, T-Mobile US portrays a disappointing price performance. In the past three months, the company’s shares have lost 11.5% compared with the industry’s loss of 10.9%.

We believe that the company’s operation in the highly competitive and saturated U.S. wireless market have led to the declining price performance. Moreover, success in the wireless service business largely depends on technical superiority, quality of services and scalability. In all three areas, T-Mobile US is far behind its peers Verizon Communications Inc (NYSE:VZ) and AT&T Inc (NYSE:T) . Such competition could limit the company’s ability to attract and retain customers and adversely affect results.

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