Last week, I wrote an article about Windstream Holdings (NASDAQ:WIN). In this article I argued that Windstream Holdings' dividend payment is not sustainable and that it is likely that the company will announce a major dividend cut in the near future. I provided several arguments in my article, such as the extremely leveraged balance sheet. Several comments disagreed with my analysis and stated that the company will grow earnings and improve free cash flow in the upcoming years. That may or may not be the case. Nevertheless, these investors overlooked one very important argument. This argument refers to Windstream Holdings' level of equity. This article elaborates on this specific argument and provides an insight into the consequences of a (too) low amount of equity.
Level of Equity
In my previous article I stated:
Windstream Holdings does not make enough net profit to pay dividends out of the retained earnings reserve. In fact, the company issues new shares from time to time and pays most of the dividends out of the additional paid-in capital.
The level of equity is as much as important as the available amount of cash to pay the dividends. Windstream Holdings cannot pay more dividends than the positive amount of the additional paid-in capital reserve and the retained earnings reserve. Windstream Holdings' total amount of equity, including the additional paid-in capital and retained earnings, was $1,104.8 million at December 12, 2012 (see table below). Windstream Holdings could pay up to $1,104.8 million in dividends, aside from all future profits.
Windstream Holdings paid quarterly dividends out of the retained earnings reserve until 2011. Since 2011, most of the dividends are paid out of the paid-in capital reserve (see graph below). The total dividend payments amounted to $531 million in 2011, in which $169.5 million was paid out of the retained earnings and $361.5 million was paid out of the paid-in capital reserve. In 2012, the portion of the dividend paid out of the paid-in capital reserve was even higher than in 2011. The total dividend payments amounted $588.8 million, in which $168 million was paid out of the retained earnings reserve and $ 420.8 million was paid out of the paid-in capital reserve.
The situation described above is not a sustainable situation. The annual dividend payment is higher than the annual net profit. Windstream Holding has only $1,104.8 in the paid-in capital reserve left and has no retained earnings reserve at December 31, 2012. I calculated that it is likely that Windstream Holdings needs to cut their dividend in 2016 because of the fact that the company does not have any reserves left. In my calculations I made the following assumptions, based on the Yahoo Finance analyst estimates and the company's third quarter earnings report:
- 596.1 million shares outstanding
- Annual dividend payment of $1 per share
- EPS 2013: $0.34
- EPS 2014: $0.42
- Annual EPS growth of 12.5% per year in 2015 and 2016
(click to enlarge)
The outcome of my calculations is presented in the graph above. The graph shows that Windstream Holdings will not be able to maintain the annual dividend payment of $1 a share in 2016 because the retained earnings reserve and paid-in capital reserve both are equal to zero. Based on my current calculations the dividend will be cut by 48% to $0.52 a share. If the company's performance in the upcoming years falls short to the current estimates, the first dividend cut will occur in 2015, followed by an additional dividend cut in 2016. On the other hand, the dividend cut in 2016 will not be as large as my current calculations if the company delivers better than expected results.
Windstream Holdings has a very low amount of equity and this amount will decrease in the upcoming years. A low amount of equity threatens Windstream holdings' dividend payments in another way. The company has a considerable amount of goodwill, other intangibles and fixed assets recorded on its balance sheet, according to the latest annual report (see table above). If the company needs to record a one-time impairment charge, the amount of equity will decrease and probably turn negative. In that case, the company needs to cancel the entire dividend in order to restore the negative amount of equity.
My conclusion that Windstream Holdings' annual dividend payment of $1 a share is not sustainable still stands. This article contributes to my previous article. The calculations in this article show that the retained earnings reserve and paid-in capital reserve are likely to decrease to zero in 2015. After 2015, the dividend payments will be maximized to the annual net profit. The dividend yield will be cut in half, based on the calculations in this article alone.
Proponents will argue that the company still offers a 6.5% dividend yield, even if the dividend is cut in half. That is a correct calculation based on the current share price. However, this argument does not take Windstream Holdings' poor financial situation into account. The very low amount of equity makes the company's dividend vulnerable to one-time impairment charges. This could lead to a negative amount of equity and Windstream Holdings needs to cancel the entire dividend.
My findings in this article do not contradict with the findings in my previous article. In fact, the findings support my conclusion that Windstream Holdings will not have the financial strength to maintain the current dividend. I still expect that Windstream Holdings will be forced to make a major cut in dividend payments in the near future.