Can Frontier Communications Sustain Its Dividend?

Mar.17.14 | About: Frontier Communications (FTR)


Frontier has a high dividend yield of 8%, but financial performance hasn’t been great of late.

Frontier is seeing improvement in customer retention and gaining market share.

Frontier’s strong cash flow and solid earnings growth in the previous quarter can help sustain the dividend.

Frontier’s focus on product bundling has proved to be successful, providing encouragement to the bulls.

Communications company Frontier Communications (NYSE:FTR) has an eye-catching dividend yield of 8%, which can attract a large number of investors toward the stock. However, Frontier's business hasn't been performing very well as its recent fourth-quarter results show us. Its revenue for the fourth quarter was $1.18 billion, as compared to $1.23 billion in the year-ago period. The decline in revenue was due to lower voice revenue, along with lower non-switched and switched access revenue, partially offset by the increase in data services revenue and subsidy revenue.

Considering this data, and Frontier's sky-high dividend payout ratio of 364%, will the company be able to sustain its dividend? More importantly, is Frontier a good long-term investment? Let's find out.

Gradual improvements

Even though Frontier Communications' revenue declined in the fourth quarter, operating income came in at $257.6 million as compared to operating income of $235.7 million in the year-ago quarter. In addition, Frontier Communications' rate of revenue decline slowed down in the last quarter and fiscal year. Also, the company's residential broadband market share improved in 84% of its markets in 2013, leading it to deliver 112,250 net broadband additions in the year, a new record for Frontier.

Frontier reduced its customer churn rate significantly by implementing several initiatives that delivered a 61% residential customer retention improvement year-over-year. Its incremental investments in key areas drove substantial improvements in customer retention, broadband growth, and customer acquisition results.

Frontier's consistent performance and long-term incentive compensation in 2013 resulted in strong shareholder returns. Frontier's bundles, pricing, and local engagement strategy execution enabled it to add 27,755 new broadband connections in Q4. Its industry-leading margins, along with its best quarterly performance in customer retention with a 10% improvement in keeping customers, are positives that investors shouldn't miss.

Frontier gained market share in 79% of its residential markets, in line with its strategy of penetrating the broadband market. However, Frontier's aggregate residential broadband market share is still in the low 20% range. Hence, it has a long way to go to reach its 40% market share objective. As such, Frontier expects the addition of broadband customers to continue in 2014, and this should lead to further revenue improvement. Also, customer acceptance of Frontier's new small business bundles introduced in early Q3, and subsequent revenue stability, reflects its continued focus on revenue improvement.

Focus on product innovation and customer retention

Frontier Secure, a product resulting from coupling security with broadband bundles, is becoming very popular among its customers along with its channel partners, leading to customer retention. Customer retention remains a major focus area for Frontier in 2014 as a driver of revenue and profitability. Residential retention improved to 59% as compared to Q4 last year, while business retention improved to 27%. Moreover, Frontier's rate of customer declines improved overall from 7% to 3%.

Looking ahead, Frontier plans to continue its cost-cutting efforts, selective investments, and new initiatives in more opportunistic areas in 2014. For example, Frontier's decision of acquiring AT&T's (NYSE:T) Connecticut wireline properties, an extremely attractive set of assets that AT&T has invested in over the years, led to an upgradation in its networks with 96% broadband coverage and over 40% U-verse coverage.

Frontier has strong experience in integrating acquisitions. It has also consistently delivered on acquisition synergies and cost reductions in the past. The integration and conversion teams are already working on key deliverables to bring excellent Frontier service to customers in Connecticut. This free cash flow-focused transaction will increase the security of the dividend and improve the dividend payout ratio, and hence, create shareholder value.

As mentioned above, Frontier took residential market share from its competitors in 79% of its markets. It is seeing excellent response from its customers and has enjoyed strong momentum in 2014 so far. The annual cable price hike that will be occurring during the first quarter is seen as an opportunity to capitalize and reinforce Frontier's value proposition and price consistency. Frontier is also focused on further expansion of its distributor partnerships, leading to excellent channel performance in the fourth quarter.

Frontier's Secure suite of products, which it offers through alternate channel partners, is seen as an excellent opportunity to improve its total sales as well as bundle attach rates. In addition, the creation of new bundle products that allows customers to purchase a broadband and Frontier Secure product as a standard double-play bundle has helped drive Frontier Secure attach rates over the 45% level in the fourth quarter.

Frontier is also looking at expanding its CPE portfolio, launching EVPL Ethernet services, building network interfaces to facilitate Ethernet traffic hand-offs. It is also combining the services offered for basic telephony applications with enhanced Ethernet offerings. Such bundled products should help Frontier generate better revenue in the future and help sustain the dividend.

Some concerns

However, analysts think otherwise. Frontier's earnings are expected to decline at an annual rate of 6% in the next five years. In addition, the stock is expensive at 45 times earnings. Also, it has a massive debt load of $8.15 billion. Coupled with a huge dividend payout ratio, all this makes Frontier's dividend susceptible to dividend cuts. However, the company delivered year over year earnings growth of 172% in the previous quarter, and if it can continue this trend in the future, its dividend has a high chance of remaining safe. The company also has sound operating cash flow of $1.5 billion in the trailing twelve months, and this should help it meet its obligations going forward.


Frontier might not have put in a stellar performance in the previous quarter and there is a chance of a dividend cut if things do not improve substantially. But, the company's strategies and market share gains paint a positive picture and should help it deliver long-term value to shareholders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.