When it comes to dividends, telecom companies have always been a nice pick. Most of the companies operating in the telecom industry are huge players and generate substantial cash flows. Furthermore, there is always a segment present in the telecom sector that allows the companies to enhance their growth. In the end, what investors want is stable growth in the stock price and their dividends paid on time, and that is what the telecom companies are good for. But even in this industry, some companies have an edge over others in terms of performance.
Frontier Communications (FTR) has been paying an impressive dividend of $0.4 with a dividend yield of 8.3%. The company's free cash flow grew by 32% in the third quarter of 2013 as compared to the second quarter and 7.5% year-over-year. However, a more important development is Frontier's decision to buy AT&T's (T) wireline business in Connecticut. Estimates show that this business will add $1.2 billion to the annual revenue of frontier communications. Furthermore, the company would be able to cut its annual costs by $200 million dollars. Frontier's annual revenue is around $4.8 billion - the addition of AT&T's wireline business will further enhance the revenues of the company.
Frontier will take a debt of $2 billion from JPMorgan (JPM) to buy the AT&T business. This would add to $7.8 billion of the current debt, increasing it by 25.6%. As a result the interest cost would increase as well. Furthermore, it should also be kept in mind that interest rates are increasing and if the company wants to further take debt, the interest cost will be higher than the current rates.
A company with high levels of debt making a cash payment of $2 billion and acquiring more assets might have raised some questions in investors' eyes. However, the company believes that the acquisition will add substantially to the cash flows resulting in a better free cash flows ratio. As a result, the company will be able to maintain its current dividends in the long-run. However, Frontier might have trouble raising cash through debt in the future as the ratings will further deteriorate.
At the moment, Frontier generates around $750 million in free cash flows and pays $400 million in cash dividends. The payout ratio for Frontier based on free cash flows is around 53%. As I mentioned above, the AT&T deal is expected to enhance the free cash flows, which should allow the company to grow its dividends and maintain a healthy payout ratio. If the company is able to consolidate the business and free cash flows grow, the dividends will certainly grow. However, even if Frontier maintains current dividends, it will remain one of the highest yielding stocks in the sector.
Next on the list is Windstream (WIN). The company pays an annual dividend of $1 with an attractive dividend yield of %12.7. Windstream has been showing remarkable improvements in its performance. Based on the third quarterly report of the company, the business services revenue on which the company is shifting focus grew by 1% year-over-year, while consumer broad band grew by 4%. Most importantly, the revenues fell by 2% while the operating costs fell by over 18% giving the company more operating profit margin. As a result, the free cash flow of the company stood around $264 million dollars.
In addition, the company has taken some refinancing activities into play which extends some debt maturities. This is expected to free up to $45 million of cash this year which was previously taken by the interest costs. As a result, this would add to $264 million free cash flow last reported making it roughly $309 million. This means that free cash flow of Windstream would further grow by about 17%. This growth rate does not include any growth that the company may have in terms of its revenues and increased efficiency. This increased free cash flow would allow the company to continue paying its current dividends.
However, the long-term debt of the company has increased by 8% in the third quarter of 2013. Since the company did the refinancing activities, the interest costs would go down for this year, but it has to pay that in the long-run. This bounds the company to show some huge growth rates this year to cope up with the interest costs which may rise the next year.
Windstream currently generates free cash flows of around $725 million and pays $592 million in cash dividends. The payout ratio for the company is around 81% based on free cash flows. Windstream has higher dividend yield compared to Frontier communications but its payout ratio is dangerously high. Investors might need to take the high payout ratio into account for the future. However, if the company is able to bring down its costs and enhance the cash flows as it has been doing in the recent past, the dividends should be under no threat.
Both the telecom stocks discussed above have good growth prospects this year. The good thing about these companies is that they have relative stable earnings compared to other industries, which adds certainty to the future cash flows of these companies. The FCF growth rates are attractive for both the companies and would allow them to pay the dividends. Most of the telecom stocks are picked due to the attractive dividend yields as the stocks in this sector show slow growth in the price due to the mature nature of the sector. These two stocks are extremely attractive for income investors in my opinion.