CenturyLink (NYSE:CTL) was one of the highest yielding telecom stocks available in the market. However, recently, the company made an interesting move by cutting the dividends and announcing a share buyback plan. The dividend cut impacted the stock price and the company lost almost 23% of its total market cap in one day. The dividend cut and the share buyback plan clearly contradicts with the future outlook of the company. The dividend cut indicates that the future cash flows are likely to come down, and the company is preparing itself to cope with a decline in future cash flows. On the other hand, the share buyback may suggest that the company is expecting a decline in earnings over the next two years, and it wants to maintain healthy earnings per share.
Affect of Dividend Cut on the Balance Sheet and Cash Flows
CenturyLink has high levels of long-term debt. At the moment, the company has long-term debt of over $19 billion. CenturyLink has been paying high amounts in interest expense due to high levels of debt. Over the last year, interest cost for the company has gone up substantially. Furthermore, the company paid $1.8 billion in cash dividends over the past twelve months and generated $3.1 billion in free cash flows. Trailing twelve months payout ratio based on free cash flows is about 60% for the company, consistent with what the management has in mind regarding the payout ratio of the company.
In addition, CenturyLink management announced that the company will use excess free cash flows to pay down some of the debt. If management is able to bring down the debt; I believe it will be hugely beneficial to the company in the long-term. However, it should also be kept in mind that CenturyLink will have to spend about $3 billion in capital expenditures every year to maintain its current position in this highly competitive market. So, the promise to pay down the debt might prove to be a tough task. At the moment, it looks like that future cash flows will decline; however, if the company is able to maintain or increase current operating cash flows, it might be successful in decreasing the long-term debt.
In the near future, dividend cut lifts the pressure on the cash flows and allows the company some flexibility in capital allocation decisions. It will also help CenturyLink in avoiding further borrowing in order to cover for a gap in cash flows if there is a decline in cash flows. Furthermore, if the debt is reduced, it will allow the company to improve profitability, enhance cash flows and strengthen the Balance Sheet. However, the task can prove to be a difficult one due to immense competition in the market.
Immense Competition and High Expenses
CenturyLink is the third largest telecommunications services provider behind AT&T (NYSE:T) and Verizon (NYSE:VZ). At the moment, broadband internet and data services is the most attractive segment of the market, and there is colossal competition among these companies. As a result, the participants have to spend substantial amount in capital expenditures as well as advertisements and marketing. Due to heavy expenditures, the margins can come under pressure. AT&T and Verizon have massive free cash flows and strong balance sheets. As a result, these two giants have no trouble in making heavy capital expenditures and financing their marketing campaigns.
On the other hand, CenturyLink does not have the financial strength to meet these two giants. Nonetheless, the company is trying to place itself alongside these two leading players through spending on marketing activities. Recently, the company announced its advertisement campaign to promote its products. CenturyLink will use Television, print and online ads to reach its customers. While this campaign may prove to be fruitful; there is a possibility that the margins will come under pressure due to increased expenses. The company is already facing the problem of declining revenue from legacy business, and the customers are switching. On the other hand, there is a lot of potential in the cloud computing and broadband services, and CenturyLink will have to increase revenue from these segments.
CenturyLink is operating in a highly competitive market where margins may come under pressure due to heavy expenditures. In my opinion, the recent dividend cut and share buyback plan were the measures to counter a decline in future earnings and cash flows. The stock price has gone up slightly since the fall, and patient investors may be able to recover some lost value. Furthermore, synergies from Qwest and Savvis may also provide some support to the company. Long-term success of the company depends taking a larger chunk of the data services and broadband market along with a decline in the long-term debt.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.