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By Siraj Sarwar

For investors who primarily are seeking dividends, the next few years are a period during which the telecom industry may be a safe harbor for their investments. Telecom, as a sector, has been able to generate large margins for a number of years, and experienced significant growth. A number of telecom companies are paying out significant dividends on the basis of enormous profits. Dividends historically have demonstrated around 40% of average total returns.

In this article, I pick three tech companies for substantial dividends. These are Frontier Communication (NASDAQ:FTR), CenturyLink (NYSE:CTL) and AT&T (NYSE:T). All the companies listed in this article have a long history of dividend payments. However, recently, Frontier Communication and CenturyLink cut their dividend; though, both companies had invested aggressively in growth opportunities in order to enhance financial health and future cash flows.

Amidst all this, all three companies have shown exceptional growth in both earnings and cash flows. Furthermore, they have strong cash flows which adequately cover dividend payments. I believe these three companies have solid investment strategy and strong financial positions to sustain and increase dividends. Let's examine each company's financial strength to support dividends.

Frontier Communications is the first stock in the compilation. It is a communication company, which provides services to small and medium-sized towns, rural areas and cities. Recently, the company announced a quarterly dividend of $0.10 per share. For the full year of 2012, Frontier paid an annual dividend of $0.40 cents/share.

How safe are dividends?

Last year, the company cut its dividends from $0.18 cent/share to $0.10 which was very painful for the shareholders. However, I believe it was the right decision for the long-term health of the company. The company is currently going though an integration process, looking to expand the size by aggressive acquisitions. Consequently, it incurred an enormous amount of debt. Below are a few key matrices indicating its financial health.

  • Current Ratio 1.23
  • Quick ratio 1.20
  • Financial Leverage 4.32
  • Interest expense [Percent of the income statement] 13.73%

Over the past two years, Frontier has been experiencing high levels of debt and interest expenses. The company's current ratio and quick ratio are low; however, these ratios are displaying no danger of insolvency. Additionally, due to aggressive acquisitions, it has paid a hefty amount of integration costs in the last two years. Thus, Frontier condensed its dividends for the company's long-term financial health.

Figures in Million

2010

2011

2012

Operating cash flow

$1,222

$1,573

$1,552

Capital expenditure

($578)

($825)

($803)

Free cash flow

$644

$748

$750

Morningstar.com

On the other hand, over the years, this tech giant has displayed an outstanding cash flow growth. In the past year alone, Frontier has generated $1,552 million in operating cash flows. It has shown strong potential to increase its operating cash flows at an enormous pace. However, at the end of 2012, the company's cash flow growth remains stagnant, mainly due to higher interest and integration costs. Additionally, free cash flows also show a similar trend. The company paid $399 million in dividends and produced $750 million in free cash flows.

In 2013, Frontier seeks to cut its expenses by 25% in order to enhance earnings and cash flows. I believe that with the dividend cuts and interest savings, its cash flow will further rise, and it looks able to sustain similar dividends for the next quarter mainly due to its debt reduction strategy.

CenturyLink Inc., is the second in the compilation. It is an integrated communications company engaged primarily in providing a broad array of communications services. CenturyLink is famous for paying high dividends and has a long history of dividend payments. Recently, the company announced a quarterly dividend of $0.54 cents/ share.

CenturyLink recently announced a new capital allocation plan. The company intends to repurchase its outstanding shares of common stock up to $2 billion. As a result, it has had to cut its quarterly dividend from $0.72 to $0.54 cents/share; though, the company plans to fund the share repurchase program mainly with free cash flows. In addition, CenturyLink seeks to reduce its debt levels by utilizing a portion of its free cash flows.

How safe are dividends?

Furthermore, the company made key acquisitions such as Savvis, Embarq and Qwest. After these acquisitions, its revenue is heavily weighted toward wholesale services and enterprise. This change in its business profile can provide larger revenue stability over the traditional residential business.

For the Q4 of 2012, CenturyLink was able to improve its year-over-year rate of revenue decline to 1.5% compared to 3.2% over the past year's quarter. The company announced operating revenues of $4.58 billion. For the full year of 2012, its operating revenue stood at $18.4 billion. At the end of Q4, it was able to increase Earnings Per Share [EPS] by $0.12 cents per share.

As another indication of their solid financial position, the company also has massive margins on sales. At the end of 2012, its gross margin stood at 58.3%, and its operating margin stood at 4.23%. This is a big achievement of margin in such a tough macro environment.

Figures in million

2010

2011

2012

Operating cash flow

$2,045

$4,201

$6,065

Capital expenditure

($864)

($2,411)

($2,919)

Free cash flow

$1,181

$1,790

$3,146

Morningstar.com

Furthermore, with its strong revenue and earnings growth, the company has had exceptional cash flows operating at a massive pace. Since 2010, it has been able to grow its operating cash flows by $4 billion. At the end of 2012, the firm's operating cash flows were standing at $6,065 million compared to $4,201 million by the end of 2011.

In addition, since 2010, the company has been making huge capital expenditures in growth opportunities. Its capital expenditure increased by $508 million over the past years. At the end of 2012, the company's free cash flows stood at $3,146 million, representing an increase of $1,356 million over the past year.

The company's free cash flows adequately cover its dividend payment. The company is seeking to maintain its payout ratio under 60%. The partnership announced a big share repurchase program of $2 billion. I anticipate, in spite of challenges that the company will generate sufficient cash flows to support both dividends and the share repurchase program.

AT&T is the third stock on the dividend collection. AT&T provides wireless and wireline telecommunications services in the United States and worldwide. At present, AT&T offers a quarterly dividend of $0.45 per share. AT&T has a long history of consistently increasing its dividends. For the full year of 2012, the company has paid a dividend of $1.77 per share.

How safe are dividends?

Over the years, AT&T has shown incredible revenue and earnings growth. Over the past three years, the company's revenue growth stands at 1.5%. In addition, it was able to enlarge its margins relative to the past year. At the end of 2012, it had a net profit margin of 5.70% compared to last year's 3.11%.

2010

2011

2012

Operating cash flow

$34,993

$34,648

$39,176

Capital expenditure

($20,302)

($20,110)

($19,465)

Free cash flow

$14,691

$14,538

$19,711

Morningstar.com

As the above table demonstrates, AT&T showed an extraordinary growth in cash flow. At the end of 2012, its operating cash flow stood at $39 billion, representing an increase of nearly $5 billion over the past year. Additionally, the company is investing aggressively in growth opportunities. At the end of 2012, the company's capital expenditure stands at $19 billion. At the same time, its free cash flows were enlarged by $4.5 billion over the earlier year's $14 billion.

AT&T is a safe pick for an income portfolio. It has returned $10 billion in dividends and $13 billion in a share repurchase program. In the Trailing Twelve Months [TTM], its dividend payout ratio stood at 140.36%, indicating increases in dividends. The company has a strong financial position to support both dividends and a buyback program. In addition, its cash flows allow it to generate constantly increasing returns for shareholders.

Source: 3 Telecom Stocks For Attractive Returns