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Windstream (WIN) is an "unfortunate" land-line communications provider in an increasingly mobile world. However it draws a lot of attention due to its massive 11.5% dividend yield. Windstream's declining land-line phone business is more than enough reason for this extremely low valuation.

However I believe that investors can extract a lot of value from this stock (if they handle it carefully) and face little downside risk in the process. Before I go on and explain how to do this keep the following things in mind:

1. Management is committed to keep the dividend intact for the forseeable future.

From the company's Q4, 2012 earnings call transcript (emphasis added):

Jeff Gardner - Chief Executive Officer

Windstream's management team and board of directors unanimously support continuing to pay our dividend at its current rate and believe it is the best way to create value for our shareholders. [...] This capital allocation strategy is well-supported by Windstream's business model and ability to generate free cash flow.

2. Windstream enjoys a more stable revenue base.

From the company's Q4, 2012 earnings call transcript (emphasis added):

Jeff Gardner - Chief Executive Officer

[...] our residential customers remain concentrated in very rural areas where there is less competition, which has contributed to a more stable consumer business.

3. Shrinking capital expenditures from 2013 and on mean increasing free cash flow.

From the company's Q4, 2012 earnings call transcript (emphasis added):

Jeff Gardner - Chief Executive Officer

Finally, we are at a different point in our investment cycle. We are winding down our investments in fiber to the tower and stimulus projects. This means, in 2013, we will be making a sizable reduction in our capex spending, and this will benefit our free cash flow trends going forward.

4. They are slowly changing their business mix away from the declining land-line phone business.

From the company's 2012 10-K filing (emphasis added):

Strategy

Our strategy is to maximize growth opportunities with our enterprise business customers while optimizing our cost structure and stabilizing the performance of our heritage consumer business. Our goal from these actions is to generate solid and sustainable cash flow over the long-term, and we intend to return a significant portion of this cash flow to our shareholders through our current dividend practice.

To accomplish our strategy, we are transitioning our revenue streams away from traditional consumer voice services to strategic growth areas of business services and consumer broadband. This diversification of our revenue stream helps us to offset revenue declines driven by consumer customer losses and wholesale revenue declines driven by intercarrier compensation reform.

In my view Windstream should be viewed by investors as a 7% dividend stock with a 50% safety cushion.

Now let me explain this. Windstream's current payout ratio relatively to free cash flow is 86% ($1 of dividend per $1.16 of FCF). Taking into consideration all the above I believe that Windstream's $1 dividend is safe for a couple of years ahead as its payout comes down. Despite that though, it still stands the risk of being cut within the next decade or so.

Here's how we should handle this assuming you'll buy WIN at $9. As long as we'll collect the 11% dividend we will break it into two parts. The first 7% will be treated as income and the second 4% part will be treated as a partial capital return.

Doing this will have reduced our invested capital by 8% to 12% in the next two to three years and will have lowered our acquisition cost to $8.28-$7.92. Even if the company cuts its dividend by 40% to $0.6 from 2015 onwards, we will still enjoy a 7% dividend income.

Disclaimer: This article does not constitute investment advice. Before you invest you should do your own analysis, seek advice from your own professional financial advisor and take into consideration your personal needs and circumstance.

Source: Windstream's Huge Dividend May Offer A Hidden Safety Cushion