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Windstream (NASDAQ:WIN) is one of the largest telecommunication providers in the U.S. The company was formed in 2006 as a result of the merger between Volar Communications and Alltell's local telephone services. Since the merger, the company has become one of the largest residential telephone providers in the United States. Windstream provides digital television packages, broadband internet, and phone services to residential, and businesses customers as well as government agencies. The company also offers cloud computing, communication and technology solutions to businesses in more than 48 states.

Financial Background:

Windstream experienced a 3% increase in the business service revenue and a 5% increase in the consumer broadband service revenues in the last quarter. In the last year, the company earned $917 million of business service revenues and $116 million of consumer broad band service revenues. Total sales declined by 2%, but the adjusted OIBDA (operational income before depreciation and amortization) of $619 million shows an increase of 2%.

The company strengthened its balance sheet in the last quarter. Windstream does not have any significant debt obligations for the near term. The company maintains a solid operating cash flow. In fact, Windstream has the potential to generate more than sufficient amount of free cash to reduce its debt load without having an impact on the dividends.

Dividend Analysis:

There is a constant decline in the landline telephone business, and Windstream has to face this unfortunate challenge. I think the gloomy business future explains the low valuation of the company, although the company pays the highest dividend yield in the sector. The president and CEO of the company, Jeff Gardner, declared;

Our management team and the board of directors unanimously support continuing the dividend at its current rate because we believe it is the best way to create value for our shareholders. We made significant progress on key initiatives in 2012 that will further strengthen our business going forward.

Windstream offered the first cash dividend of $0.204 in September 2006. Since then, the company has been a stable dividend payer. Windstream has been paying a $0.25 dividend each quarter, which amounts to a total of $1 dividend a year. Its dividend yield of 11.64% is one of the highest among the domestic telecom companies. After the dividend cut of CenturyLink (NYSE:CTL) and Frontier Communications (NASDAQ:FTR), the market also expected a similar move from Windstream. As a result, the stock is trading almost 22% below its 52-week high.

While I think Windstream should be priced above $10, the stock has not yet crossed $9. Therefore, Windstream looks like a cheap deal to me. It might be claimed that the dividend is not safe due to high payout ratio, but the company has been paying dividends out of its free cash flow. Also, its price to cash flow of 2.9 puts it among the cheapest stocks in the market.

WIN

Industry Avg

S&P 500

WIN 5Y Avg

Price/Earnings

31.1

28.8

16.2

22.0

Price/Book

4.6

1.6

2.2

10.3

Price/Sales

0.8

1.0

1.4

1.4

Price/Cash Flow

2.9

4.6

9.4

*4.5

Dividend Yield %

11.5

4.0

2.3

9.5

Source: MorningStar.com (*Price/Cash Flow uses 3-year average.)

The company has been putting great efforts to keep its dividend payout and follow a stable cash dividend for last 5 years.

On the negative side, the company has a pretty low profit margin of 2.4%. The debt to equity ratio of 8.14 is also another red flag against the dividend safety. The stock also looks on the pricey side of the market based on a trailing P/E ratio of 30.2 However, excluding depreciation and amortization, the company is generating very substantial income. It earned about $1.16 free cash flow in 2012. The following table gives the evolution of company's fundamental ratios over time:

Gross Margin %

Net Income
(in $ million)

EPS

Payout Ratio %

BV Per Share

FCF Per Share

Debt/Equity

2007

63.9

917

1.94

51.6

1.47

1.41

7.62

2008

63.9

413

0.93

102

0.57

1.73

21.24

2009

62.8

335

0.76

131.6

0.6

1.9

24.06

2010

62.2

311

0.66

151.5

1.65

1.45

8.65

2011

58.2

172

0.33

303

2.9

1.05

5.97

2012

52.9

168

0.28

357.1

1.88

1.16

7.35

Source: Yahoo Finance

Summary:

Windstream has pursued an aggressive acquisition policy to diversify its business. Although the acquisitions have provided with the required diversification, the company still operates as a traditional landline-telecom business provider.

These acquisitions and diversifications have helped the company boost its sales revenue, but that came with a huge cost. Its financial leverage is similar to that of mortgage-backed REITs.

However, from a dividend perspective, Windstream sounds like a sound investment. Its competitors, Frontier and CenturyLink, have cut their dividends to change their capital allocation policies. The moves from its competitors caused a panic among investors. As such, Windstream lost a substantial portion of its market cap in an upward moving market. That low valuation makes it a compelling buy.

While there is no guarantee on Windstream's future dividend hikes, the management seems to be committed to offer $1 per annum. Surely, that is not a risk free yield, but it could provide a leveraged exposure to double-digit yields in a low yield market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: How Safe Is Windstream's Dividend?