Seeking Alpha
Value, utilities, large-cap, mega-cap
Profile| Send Message| ()  

Windstream Corporation (WIN) provides data center and managed-hosting services to businesses. It also provides local phone, broadband, digital TV and high speed Internet services. I am bearish on the company, as it has failed to bring any improvement in its earnings. Though it offers an attractive dividend yield for income-seeking investors, I believe this is not sustainable. WIN's business services and high speed internet are doing well, but other than that it has limited growth potential. Also the company's balance sheet does not paint an encouraging outlook, as it is highly leveraged.

Financial Performance 2Q'13
Total revenues declined by 1.85% YoY, as growth in the telecommunication centre moved away from traditional voice to data services. However, WIN's core business service and broadband segment, which contribute around 72% to total revenues, managed to perform well. Business service revenue was up by 2.2% due to the efficient management of the sales force expansion of data centers. WIN has been planning to open four new data centers this year. Also, broadband service experienced a rise of 5.5% YoY. Both high speed Internet and business service experienced a rise of 7% YoY in the average revenue per unit (ARPU).

Lower intrastate access rates and lower switch access revenues from wireline customers managed to decrease wholesale revenues to $151 million, with a decrease of 13% YoY. The carrier transport business has also been facing difficulties, as demand for telecom operators has been low.

Guidance
The company has lowered its 2013 revenue guidance to -3%-to-1% YoY because of lower business sales and continuous pressure on the carrier transport business. WIN has reaffirmed its guidance for adjusted OIBDA of -3%-to-1% YoY and free cash of 13%-25% YoY. Capital expenditure is expected to remain $815-$830 million in 2012.

Discounted free cash flow evaluation
I have used free cash flow estimates until 2016 and a 6.95 % WACC (using cost of equity of 9.20% and after-tax cost of debt of 2.1%). Furthermore, I have used a terminal year growth rate of 0.1%.

2014

2015

2016

Terminal Value of FCF

Estimated Free Cash Flow

$985

$960

$955

$13,966

Present Value

$921

$839

$781

$11,416

Total Value to firm=$921+$839+$781+$11,416=$13,957million
Total Debt= $8,868 million
Total Value to firm - Total Debt = Total Equity value
$13,956 - $8,868= $5,089 million
Shares Outstanding = 592.8 million

Target Price = Total Equity Value/Share Outstanding
$8.59 = $5,089/592.8

The company is currently trading at $8.54 and my price target is $8.59, which means that the company is fairly priced and I do not expect any price appreciation.

Debt

Companies

Total debt/ Equity

Interest coverage ratio

CenturyLink (CTL)

111.88x

1.90x

Frontier Communications (FTR)

207.34x

1.63x

WIN

945.45x

1.66x

Source: reuters.com

The company is highly leveraged with a total debt-to-equity ratio of 945.45, which is way higher than that of its competitors. Also, the interest coverage ratio of 1.66 raises significant concerns for investors. Also, it is expected to decline further with the rising interest rate scenario. I believe that WIN will not be able to improve upon this, as it is reporting a constant decline in the EPS for the last three years. Furthermore, the company has limited growth opportunities available internally. So, its growth is primarily dependent on mergers and acquisitions, which will further deteriorate the company's balance sheet.

Dividends

(click to enlarge)

Source: reuters.com

WIN is currently offering a very healthy dividend yield of 11.71%. The company's poor financial performance in the recent quarters has raised questions about the safety of its future dividends. The company has a very high payout ratio, which means that it will face problems in maintaining its dividend yield. In the recent second quarter, WIN generated around $170 million in the form of free cash flow, which is sufficient to maintain $148 million of dividends. So, WIN is distributing around 87% of free cash flow to shareholders, which means that it has limited growth opportunities. Also, it helps explain the company's high leverage.

So, in order to expand its market share and strengthen its operations, WIN must look to cut its dividend yield to look for growth opportunities and improve the company's balance sheet. One of its competitors, CTL, has opted for the same strategy and managed to improve its future growth prospects.

Conclusion

Companies

Forward P/E

P/S

Next 5yr growth rate

CTL

11.97x

1.07x

1.35%

FTR

18.89x

0.89x

21.80%

WIN

18.57x

0.83x

-11.50%

Source: Yahoo Finance

The company is trading at 18.6 times its forward earnings, at a premium to CTL. It also has a negative growth rate of -11.50% for the next 5 years. However, the company offers a healthy dividend yield, which I believe cannot be sustained for very long. So, the company needs to cut its dividends to look for growth opportunities and needs to use funds to invest in new projects to remain competitive, as the company operates in a capital-intensive industry.

Source: Unsustainable Dividends Pose Threat To Windstream's Prospects