The telecommunications sector has been as of late going through immense changes because of technological innovation, as the focus shifts from voice to data networks. Verizon Communication (VZ) and AT&T (T) have widely benefited from wireless growth. However, rural local exchange carriers (RLEC) failed to meet the smooth transition, and legacy voice revenues still form a major chunk of their operating cash flows. Other than traditional voice services, they offer high-speed internet and broadband services along with data hosting and cloud services. In this article, I will be discussing and comparing three major rural exchange carriers, which include Windstream Holdings (WIN), Frontier Communications (FTR) and CenturyLink, Inc. (CTL).
The aforementioned companies are heavily dependent on their dividends, as it is a major attraction for investors. Among these RLEC companies, WIN enjoys the highest dividend yield, as shown in the table below, but it has the highest payout ratio calculated by dividing the third quarter's dividends by free cash flows. On the other hand, CTL and FTR offer more sustainable yields with decent payout ratios. Furthermore, CTL has been aggressively pursuing a share buyback program, and so it has purchased 38 million shares for $1.3 billion.
$ Dividends Paid (millions)
Free Cash Flow
Source: company data and yahoo finance
As you can see from the table given below, RLEC companies have much higher leverages than wireless service providers, because the major source of their cash flows, legacy telephone services, is constantly on the decline. VZ debt-to-equity ratio is on the higher side due to its recent buyback of 45% of Verizon Wireless, but its interest coverage ratio of 9.25x paints an encouraging outlook. Among RLEC companies, CTL and FTR are comfortably placed with manageable debt numbers. However, WIN's management failed to manage its debt, as it is 1034.96 times to its equity, which means that in the near future, it has to cut down on its dividends and capital expenditures. Furthermore, raising funds for future acquisitions will not only be difficult but highly expensive as well.
Total debt/ Equity
Interest Coverage Ratio
The key growth drivers for the companies are broadband internet and TV services, as they form a major part of their operating revenues. In the recent last quarter, CTL added 33k and 17k new broadband and video subscribers, respectively. It also has the smallest loss of voice customers among the other aforementioned companies. Furthermore, CTL also enjoys the largest network of data centers with an international outreach. In the future, data centers will be an important stream of revenues, as demand for data will continue to rise.
On the other hand, FTR also managed to increase its broadband subscriber base by around 29k new connections. Recently, it decided to buy T's land line, broadband and TV operations for $2 billion. If this deal wins the approval of regulatory authorities, it is expected that the company will add 90k voice connections, 415k broadband customers and 180k U-verse video subscribers. Lastly, WIN reported a loss in its subscriber base, while its peer companies substantially improved its subscriber base. It lost 11K and 5.4K broadband and video customers in the recent third quarter.
Fiscal Quarter End Earnings Surprise
If we look at the historical performance, CTL has been consistently meeting analyst expectations and has never delivered a negative earnings surprise in the last three quarters. FTR managed to improve its performance after the first quarter, and it managed to meet analyst expectations. Finally, WIN's performance was not up to the mark.
Next 5-years growth rate per annum
Source: yahoo finance
I believe both FTR and CTL paint an encouraging outlook for the future. They both are also trading at the bottom end of their 52-week ranges, which means we can expect a rise in their share prices. FTR also has the highest growth rate for the next 5 years and it is also the cheapest, as indicated by the lowest PEG. However, my pick for 2014 among RLEC companies is CTL because of its decent payout ratio, lower leverage and solid financial performance. Also its widespread data centre business provides a compelling opportunity for the future.