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by Cagdas Ozcan

Introduction:

Frontier Communications Corporation (FTR), incorporated in 1935, is the sixth largest local exchange carrier in the country. It provides regulated and unregulated data, voice, and television services to residents, businesses, and enterprises in the US. Primarily, it offers services to small and medium sized towns and cities including rural areas and smaller communities. It also offers computer technical support, broadband internet, and digital TV services in more than 27 states in the country. Frontier Communications, with a $4.07 billion market capitalization, is the smallest in size as compared to AT&T (T), Fairpoint Communications (FRP), and Country Link (CTL). Despite being a relatively small company, Frontier's current dividend yield of 9.83% is the highest in the telecom sector.

A brief analysis:

Dividend-seeking investors pay great attention to the consistency and rate of raising the dividend-payout rather than just the dividend yield. A company with a high but fluctuating dividend payout is not considered to be stable. If the company reduces the dividend payment, the investors start losing their trust and begin selling their shares. The market does forgive but not those who cut dividends in the telecom sector. Investors prefer the company that constantly raises the dividend, as this way they feel their investment more secure and profitable.

Overall, the companies in the telecom sector pay good dividends and exhibit high dividend yields. For the same reason, Frontier Communications is a very popular and attractive telecom stock for the dividend investment. According to the Yahoo Finance data, out of 25 domestic companies in the sector, 13 of them pay regular dividends. The average yield of dividend paying companies is 5.10%, whereas the dividend yield of the whole sector is 3.3%. Frontier clearly stands out for its current 9.83% dividend yield. Frontier Communications is the second highest amongst the top dividend-yielding telecom companies. Below is the list of these best dividend-yielding companies.

Company name

Ticker

Price

Market Capitalization $ billion

forward annual yield

Payout ratio %

Annual dividend growth during the last 5 years

BCE, Inc

BCE

45.66

35.4

4.95

68

9.44

Chunghwa Telecom Co., Ltd.

CHT

31.05

24.09

4.64

99

13.07

Consolidated Communications holding

CNSL

17.05

0.68

9.09

388

0

CenturyLink, Inc.

CTL

34.39

21.52

6.28

218

51.31

EarthLink Inc.

ELNK

5.73

0.59

3.49

136

Frontier Communications Corporation

FTR

4.07

4.06

9.83

267

-17.54

AT & T, Inc.

T

36.68

201.43

4.91

145

2.38

Verizon Communications

VZ

47.96

137.08

4.3

655

3.67

Windstream Corporation

WIN

8.56

5.05

11.68

435

0

Source: Yahoo Finance

EarthLink Inc. has started paying the dividend since 2009, which is less than 5 years, so 5-year growth in the annual dividend could not be computed. Although the company has the second highest dividend yield, it is the only company with a negative 5-year dividend growth.

(click to enlarge)

Source: NASDAQ.com

As Frontier failed to raise its dividend payout for many past years, the share price of the stock has declined substantially. Therefore, the current share price of $4.07 is not much lower than the $4.17 on February 19, a day before the dividend was announced for the first quarter of 2013. Although a dollar amount of the dividend payment is constant at 0.1 for the last five quarters, its payout ratio has declined significantly as evident in the table below.

Annual key indicators of the company

Earnings Per Share USD

Dividends USD

Payout Ratio %

2004

0.23

0.5

217.4

2005

0.6

1

169.5

2006

1.06

1

128.2

2007

0.65

1

153.9

2008

0.57

1

175.4

2009

0.38

1

263.2

2010

0.23

0.88

380.4

2011

0.15

0.75

500

2012

0.13

0.4

307.7

Source: MorningStar.com

A very interesting fact is observed when we compare the EPS with DPS. Except in 2006, the company has been paying a much higher dividend than it actually earned. It looks quite strange, as normally the dividend is paid out of the earnings the company has earned. But the unusual dividend payout of Frontier Communication is not an exception, as many other telecom service companies are practicing the same. This practice may give the companies a short-term benefit of raising the demand of the stock, but it is not healthy for the financial health of the company. Frontier's all price multiples except price/earnings are lower than the industry averages and S&P 500. Hence, Frontier stock is also underperforming like most of the other companies in the telecom sector.

In order to pay higher dividends than actually earned, companies rely on the debt which offsets the worth of the company. So, even if painful for the investors, the company's decision to cut the dividend payout is the right decision at the moment. Frontier will not only be able to pay out its debt but will improve its financial flexibility and certainty. This will enhance the financial position of the company in the long run and enable the company to invest in projects which yield a high return.

Final Words:

Despite observing the high dividend yield, the stock of the company is down for the last one year. The share price of the company fell by 5% for the year. Although challenges remain, the dividend cut has put the Frontier Communication on a strong financial footing. The company's total debt to equity ratio of 200% is an alarming situation, which is significantly higher than the industry average of 72%. To be compatible with the industry averages and competitive in the telecom sector, a reduction in the dividend cut was the need of the time. The share price of the company had already fallen, so there may not be any other test it has to face now.

Analysts may conclude that the dividend cut is immense, but we think that the company will concentrate on its integration to improve its financial strength. But an important question is how long Frontier will take to revise its dividend policy? If the company will not be able to reverse the trend in declining revenue, it may have to go for another dividend cut. Yet another important point is how long the investors will be waiting to see any improvement in the financial position and dividend payout of the company? It does not seem to be the game for a few months or quarters, but it may take years for the company to shake it out completely. Till then, the dividend-payout will remain the question under discussion.

Source: Frontier: What's The Deal With The Dividend?