One difficult part of investing requires that investors not follow the herd. In the case of CenturyLink (NYSE:CTL), the company continues to produce solid free cash flow as the market harps on revenue growth and legacy business lines. The stock now trades back around 52-week lows even while providing a net payout yield of around 12% and growing.
The company is the third largest telecommunications provider in the U.S. It provides data, voice and managed services in local, national and select international markets. The stock market though focuses squarely on its legacy local voice business and misses the transition to data services including fiber to wireless towers and growing television service.
CenturyLink falls into a group of legacy local telecom providers that have become high yielding utilities mostly hated by investors due to the lack of growth. A lot of investors prefer the higher dividends at Frontier Communications (NYSE:FTR) and Windstream Holdings (NASDAQ:WIN), but the new capital allocation strategy at CenturyLink should drive better returns from these stock levels. Is the stock a must own based on strong Free Cash Flow (FCF) and attractive yields?
Revamped Business Lines
As with all of these telecom providers that lack wireless services, the shift towards data and television is in full force. The company added 12,200 Prism TV subscribers during Q2 to push the total to 132,000 customers. It also made great progress towards connecting wireless towers to fiber. In total, the company now has nearly 16,700 fiber-connected towers with a goal of adding a total of up 5,000 this year alone. The Savvis Cloud offering continues to see a ramp up of demand along with slight growth from collocation and managed hosting services. In the business segment, high-bandwidth offerings such as MPLS and Ethernet services saw growth of nearly 5%.
Unfortunately, the slight growth of these strategic segments weren't able to overcome the decline in legacy revenues. In total, Q2 operating revenues declined to $4.53 billion from $4.61 billion in Q212. Even with the decline, operating cash flow was held mostly in check due to falling operating expenses. The stability of operations should provide assurance to investors that the company has a long-term sustainability.
Unfortunately Opportunistic Yields
Though the company has very attractive yields from a huge buyback implemented recently, most investors were disappointed that the company chose to slash the dividend in order to make the shift to stock buybacks. This allocation strategy (see Did CenturyLink Just Become A Gold Mine To New Investors?) originally sent the stock to 52-week lows back in February.
The company bought back 12.8 million shares during Q213 for $465 million at an average price of $36.33. In total, the company had spent $1 billion on buybacks this year through August 6. The repurchase of 4.6% of the outstanding shares should help boost earnings per share in the upcoming periods. In addition, the company is busy buying back shares now with the FCF generated to the extent that the $2 billion stock buyback plan could be finished in the first year. An interesting point made by the CFO at the Merrill Lynch media conference was that the completion of the buyback would reduce the dividend payouts by $125 million.
As the chart below shows, the company is returning a similar percentage of capital to investors as Frontier and Windstream that only pays dividends. The combination of the net buyback yield and dividend yield equals the net payout yield:
Strong Free Cash Flow
With operating cash flows margins of around 40%, the company can't be all bad. The business ability to generate revenue may be flat to down, but it still generates substantial margins and cash flows. With the revamped business lines highlighted above, the business isn't going anywhere in the future. Mobile services might be essential, but so are the fiber linked to the wireless towers provided by CenturyLink.
The company expects to generate operating cash flow of nearly $7.5 billion for the year and the all-important FCF of over $3 billion. The stock only trades at an incredibly low 6.5x FCF. See the slide from the latest earnings presentation below:
For a comparison, Windstream expects full-year FCF to reach around $900 million or 5.3x market value. The 12.5% dividend amounts to a payout of roughly 65%. Frontier expects to reach FCF of around $875 million or 4.8x market value. The 9.3% dividend amounts to a payout of roughly 50%.
One of the best parts of the CenturyLink story for new investors is the ability to buy the stock at 52-week lows due primarily to the decision to shift the capital allocation strategy towards stock buybacks and away from dividends only. See the chart below:
Chart - 2 Years
The general sector trades at favorable FCF valuations and provide investors with attractive yields. The opportunistic buybacks by CenturyLink should help provide strong returns for the stock in the next year, as investors continue to overlook the ability to generate tons of FCF that can be returned to shareholders or used to pay down debt.
Disclosure: I am long CTL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.