CenturyLink (CTL) suffered massively due to the recent dividend cut, and the stock had one of the worst days in its recent history. The reaction of the market was normal as one of the most important factors for investors is high dividend yield offered by traditional telecom companies. While the dividend cut was painful for the existing investors; I believe it was needed for the long-term viability of the company. Traditional telecom companies are facing declining revenues due to the shift of customers towards cellular phones and mobile devices. As a result, cash flows of these companies have come under severe pressure.
A fall in price due to the dividend cut allowed smart investors to make money as they realized that the dividend cut is actually good for the health of the company in the long-term. In my opinion, CenturyLink is well positioned now to exploit future growth opportunities, and the dividend cut has provided it some flexibility.
Impact of the Dividend Cut on Cash Flows
In order to determine the impact of a dividend cut on cash flows, I have analyzed cash flows statement of the company. In the financing activities portion of the cash flows statement, payment of long-term debt and cash dividends are two of the biggest cash expenses. CenturyLink paid $5.118 billion for the settlement of long-term debt - in the meantime, the company issued new debt of $3.362 billion, reducing the overall long-term debt by $1.756 billion. Normally companies do not pay off debt from cash flows alone, new debt is issued to finance the older debt. CenturyLink has massive amounts of debt ($19.4 billion at the end of the year), and the company is trying to reduce these debt levels.
CenturyLink has over 618.5 million shares outstanding at the moment - after the recent dividend cut, annual dividend for the next year will be $2.16 per share. At the current dividend levels, the company will have to pay $1.33 billion in cash dividends over the next year, allowing the company to save $500 million. CenturyLink announced that savings from dividend cut will be used to repay some of the outstanding debt, which means the company will be able to repay up to $1 billion in long-term debt over the next two years, if it chooses to do so. From the announcement, it is clear that the company wants to maintain dividends at the current level.
However, I do not think that all the savings will be used for the repayment of the debt. Cash flows statement has another item that is on the rise, capital expenditures. I believe some of the savings from the dividend cut will be directed towards the capital expenditures.
Why the Stock is Attractively Valued Now?
The stock is up 10% since the news of the dividend came out, clearly suggesting that investors spotted an opportunity to buy after the bad news. In my opinion, the dividend cut has made CenturyLink more attractive, and there is still upside potential in this stock. At the moment, the main growth drivers for the company are broadband data services. Regional and wholesale markets are declining while enterprise market, both network and data hosting are growing for the company. CenturyLink added substantial number of new subscribers to broadband subscriber base.
In the near future, legacy business of the company will continue to decline; as a result, focus should be turned to the broadband market. However, the data services market is fiercely competitive and the company will have to spend a substantial amount of cash to win this market. In my opinion, business will not be able to show overall growth in the next two years. However, the broadband segment will continue to grow and add substantially to the revenues. Over the next two years, debt repayment and increase in capital expenditures should allow the company to manage its business better and exploit the growth opportunity. As a result, I believe CenturyLink will carry on its steady rise over the next year.
Sometimes it is important to make a short-term sacrifice to enjoy long-term benefits. The dividend cut was certainly a tough decision for the company; nonetheless, it was the right one. Cash flows and revenue of the company are under pressure, and the pressure will continue in the near future. As a result, the company made a wise decision and decided to save cash where it was the easiest to save. The current dividend yield (6%) is not that terrible, and it is still one of the highest dividend yields in the sector. Post-dividend cut CenturyLink is far more attractive than the pre-dividend cut CenturyLink.