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by Ahmed Ishtiaq

CenturyLink (NYSE:CTL) has been treading on thin ice for a long time now, and our worst fears have been realized. We have been concerned about the high levels of the debt of the company and suggested in our previous articles that it can create a problem for the company. Traditional telephone companies are attractive to investors due to high dividend yields. However, rural customers are now rapidly moving towards the mobile phones, which have resulted in shrinking margins in the industry. Shrinking margins and high levels of debt is not a pretty looking combination, and it has resulted in a dividend cut for CenturyLink. I mentioned in my previous articles that if the company has one bad quarter, dividends will be the first item to be affected.

Fourth Quarter and Full Year results

CenturyLink announced its fourth quarter and full year results. In the statement, the company said that it was happy to decrease the revenue loss rate to 1.5% from 3.2% a year ago. When a company is happy to report a revenue decline, it clearly tells you the state of the industry. I understand that almost all of the participants in the industry have the same problem. However, declining revenues and eroding margins finally come to haunt the investors. Revenue for the fourth quarter and full year stood at $4.58 billion and $18.4 billion, respectively. The decline in quarterly revenues mainly came from a decline in legacy revenues. Furthermore, full year revenue declined by 1.7% for 2012.

Free cash flow for the company stood at $610 million. Free cash flow figures do not include special items and integration-related capital expenditures. Moreover, operating cash flows for the company increased (excluding special items) to $1.91 billion from $1.85 billion a year ago. High-speed Internet is the most lucrative segment at the moment. CenturyLink currently has 5.85 million high-speed Internet subscribers, including 41,000 new subscribers the company added during the fourth quarter. CenturyLink will have to penetrate deeply into this segment in order to increase its cash flows. The company is going in the right direction concerning high-speed Internet; however, it needs to have a stronger foothold in the market.

Long-term debt of the company currently stands at $19.4 billion, which is a little high for my liking. CenturyLink paid $1.3 billion in interest expense, 23% more than the previous year. Declining revenues, shrinking margins and increasing interest expense in the current low interest rate environment is not impressive. All these factors added up to the dividend cut. CenturyLink management tried to avoid the inevitable for as long as it could, but with such operating results, it was going to be an impossible task to carry on these dividends forever.

Change in the Capital Allocation Policy and Strike Issues

CenturyLink's decision to buyback $2 billion worth of shares is a bit baffling. Investors prefer dividends over share repurchase programs, and sell off is a clear indication of where investor preferences lie. It can be a sign that the company expects to have lower earnings over the next two years, and wants to maintain a good EPS. CenturyLink outlook for the next year is not very promising according to the company. There will be a fall in revenues and earnings over the next twelve months. According to the new capital allocation strategy, quarterly cash dividend has come down to $0.54 per share from $0.725 per share. The company will use a portion of free cash flows to pay its outstanding debt. CenturyLink wants to keep leverage at 3.0 times EBITDA. A dividend cut was not the only bad news investors received. There are also some issues between the top management and labor. The Communication Workers of America has authorized its executive board to set a strike date. The union represents 13,000 CenturyLink employees.

Impact on Peers

CenturyLink's dividend cut affected the whole sector, and most of its peers also lost substantial value. Windstream Corp. (NASDAQ:WIN), another high yield stock, was the second biggest loser after CenturyLink with a decline of 8%. I have analyzed Windstream dividends in detail in my previous articles. I believe Windstream is also walking a tight rope, and it can also cut its dividends. As I have mentioned above, overall condition of the industry can force the participants to reduce cash disbursements. Frontier Communications (NASDAQ:FTR) lost 7% after the news. However, Frontier has already taken steps and reduced its dividends. I believe the company will be able to maintain its current dividend levels, so Frontier looks like the safest investment at the moment.

Summary

Dividends play an extremely important role in attracting investors in the current low yield environment. As a result, investors have been putting money in high yield telecom stocks. However, a small dividend cut for these companies can prove to be devastating for investors, and a fall of 22% in one day is proof of that. On the other hand, there is always a chance of emotional trading after bad news. As a result, there might be an opportunity to make some short-term gains. However, personally I would stay away from CenturyLink, and try to find a better alternative to meet my income needs.

Source: CenturyLink: The Worst Happens After All