The recent announcement by CenturyLink (CTL) that it was reducing its dividend from $.725 per quarter to $.54 per quarter sent a shock wave through the "small" telephone company (telco) market. The sector features many high-yielding stocks and investors are understandably concerned about whether dividends will be sustained.
Before going into this question in a little more detail, a few introductory observations are in order. This series will deal with "small" telcos - companies with landline exposure excluding the big boys - AT&T (T) and Verizon (VZ). This group of companies consists of entities which have some traditional local telco service activity but have also expanded into broadband and business services - including data centers. Most of these companies have not gotten into the mobile or cellular telco business but there are some exceptions. These companies all have substantial debt and a substantial asset base. Their income statements include very large depreciation deductions but they also make substantial ongoing investments. Cash flow can be very different from income.
As a general rule, the landline telco business has been in decline as customers abandon their traditional telephone service and move in the direction of internet telephony or total reliance upon mobile phones. This part of the business is declining virtually everywhere. On the other hand, those customers still using traditional telephone service have now had a long time to switch and are probably going to abandon that service at a relatively slow pace. Indeed, it may be the activity of the Grim Reaper, which determines the pace of decline in this line of business. These companies have tried to offset this decline by offering broadband service and business communications and data services. In most cases, they have met with some success in this regard and total revenue is generally flat or very slowly declining for most stocks in the group. In a number of cases, share prices have moved down creating a relatively high dividend yield. In a world of yield-starved investors, these stocks invariably attract interest; the fact that many of them are trading at very high dividend yields reveals that an assumption that dividends may well be reduced has been "baked into" the price. If that assumption is unduly pessimistic, there is the potential to do reasonably well with some of these stocks. A lot depends upon the future pace of capital investment. If a company's capital investment necessary to break into the new lines of business is now behind it, there should easily be sufficient cash flow to support generous dividends. If there is a continuing need for massive capital investment, dividends could become problematic.
The table below provides data concerning CTL, Frontier Communications (FTR), Windstream (WIN), TDS and Cincinnati Bell (CBB). Dividend yield data is based on a projection of current dividends. Market cap and price data are derived from Yahoo Financial. Annual dividend expense is derived by multiplying current quarterly dividends by four times the number of outstanding shares. Debt and cash flow data is derived from SEC filings. In many cases, I have projected data from nine months of 2012 to produce annualized full year numbers by simply multiplying the nine months data by 4/3. I have calculated "cash flow" by adding depreciation to earnings and subtracting capital expenditures. I will discuss this methodology in more detail below.
|Price||Yield||Market Cap||Dividend Expense||Cash Flow||Net Debt|
As noted above, I am using current dividends so that CTL's dividend expense is based on a projection of its reduced dividend for four quarters. CBB does not pay a dividend. CBB is also in the process of spinning off its data centers into a new REIT. TDS spends a great deal on capital expenditures, possibly because it is active in the mobile market.
My methodology for calculating "cash flow" is unorthodox and may be controversial. For example, "share based compensation" is deducted from income and is usually added back in to derive cash flow. I do not do this because the issuance of new shares to option recipients will cost a dividend-paying company cash either in the form of the dividends on the additional shares or the cost of buying back enough shares to keep share count constant. Similar considerations apply to non-cash deductions like bad debt reserves, tax accruals and pension liabilities. I would add in an extraordinary goodwill write off to derive cash flow but many other items normally added back in represent real costs to be incurred by the company and excluding them from cash flow creates a misleading impression of the company's sustainable ability to generate cash for owners.
In this regard, my numbers suggest that WIN has dividend expense in excess of cash flow. This is based on 2012 data and there is reason to believe that capital expenditures will decline in 2013 thereby increasing cash flow in coming years. Readers should review this analysis (pdf) provided by the company and supporting the company's assertion that the dividend is sustainable.
CTL is the largest in the group and is the heir to the old U.S. West business. It resells mobile service and thereby derives income from this line of business. Its recent dividend reduction drove the stock price down and may have created a buying opportunity. At the current level, it certainly appears that the dividend is sustainable.
FTR descends from Citizens Utilities and operates telco operations in numerous locations. It has a high dividend yield and very high debt but appears to be in a reasonably strong position to continue the dividend.
As noted above, WIN has a very high dividend yield and it appears that there may be some pressure on the dividend. On the other hand, management is very committed to the dividend and has explained in detail why it believes the dividend is sustainable.
TDS pays a relatively small dividend and is active in wireless. From time to time there has been speculation that TDS would be a takeover candidate because of its presence in the wireless market. It continues to have a large capital expenditure budget.
CBB is, as noted above, in the process of spinning off certain data center operations into a REIT. It does not currently pay a dividend and is the smallest of the group.
I have not traditionally invested heavily in this group of stocks but, with the pull back set off by CTL's dividend reduction, I am starting to kick the tires. None of these will be much of a "growth" opportunity but, as I have often said, everything depends on the price and, at a low enough price, some stocks in this group could become attractive.