Frontier Communications (FTR) provides communications services to residential and business customers in rural areas and small and medium-sized towns and cities in the United States. The Company offers a variety of voice, data, Internet, and television services and products. The company has almost tripled its size through acquisitions, and currently it is an important player in the rural market. However, traditional telephone services companies are currently facing the problem of declining revenues. The biggest reason for falling revenues is the switch by customers to wireless and mobile.
Frontier has lost substantial revenue over the past year, and the same trend is present in the net income of the company. Last year, Frontier also cut its dividends in order to decrease pressure on cash flows and counter future decline in revenue. It is currently one of the highest yielding stocks in the sector, and attracts a lot of income investors. However, the stock has not shown much capital appreciation, and currently trades around the same levels as it did at the start of July 2012.
Opportunities and Challenges
The biggest challenge Frontier faces is a change in customer preferences. At the moment, the customers are moving towards mobile phones and giving up landline connections. As a result, the company is losing substantial revenue. At the moment, the company is losing almost 1.60% of its total customer base each quarter. Landline connections are on a decline for other players in the market as well. However, broadband and Satellite TV segments are attractive at the moment. Frontier added 5,300 new broadband and 20,900 satellite TV customers. Meanwhile, the company lost 2,800 FiOS customers. Frontier's more lucrative market segments should make up for the lost revenue from landline business; however, broadband and satellite TV segments are currently falling behind.
Nevertheless, there is a big opportunity available in the data services segment. High-speed internet has become extremely important in our everyday life, and presents a great opportunity to the operators. However, it is a fiercely competed segment. AT&T (T) and Verizon (VZ) are the biggest players in the data services segment. Verizon's Wireless services bring massive amounts of revenue and cash flows to the company. CenturyLink (CTL) is the third biggest player that is also focusing on data services at the moment. Despite being an attractive market segment, it is not easy to penetrate this segment. Furthermore, in order to penetrate this market, the company will have to spend substantial amount on capital expenditures.
Are Dividends Under Threat?
Dividend yield is one of the most important factors for Frontier's investors. At the moment, the company pays an annual dividend of $0.40 per share, yielding 9.80%. Frontier's yield is obviously one of the highest in the sector. However, it is important to take into account the current and future trends in the operating and free cash flows. Frontier's operating cash flows came down by almost 1.28% over the past year. The company paid about $399 million in cash dividends over the past twelve months. At the same time, Frontier generated $750 million in free cash flows. Frontier's payout ratio based on free cash flows is about 53% at the moment. Current payout ratio is manageable for the company.
The company has spent around $800 million in capital expenditures in each of the last two years. However, guidance for capital expenditures during the current year has been decreased, and capital expenditures are expected to remain below $700 million. Furthermore, guidance for free cash flows indicates that the company expects the free cash flows to increase. However, it is clear that this increase will not come from cash flows from operations. Free cash flows will rise due to a decrease in capital expenditures. Nonetheless, free cash flows should be enough to cover dividends, and the company should be able to maintain its current dividend payments.
Investment in Frontier is usually motivated by its sumptuous yield. While the companies in the industry remain under pressure, I believe Frontier's current dividends are under no threat. Cash flows of the company provide enough cushion to its dividends. On the other hand, I do not think Frontier's price will rise substantially. It is a good investment for dividend hunters. However, growth investors should look elsewhere.