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Summary

  • Company progressing in efforts to strengthen subscriber base and improve ARPU.
  • FTR’s core business set to benefit from acquisition of T’s wireline assets.
  • Analysts expecting company to grow by 13% over next five years.

I reaffirm my "bullish" stance on Frontier Communications (NASDAQ:FTR). The company reported mixed results for 1Q2014, but in the long term, its performance is likely to be positively affected by a controlled cost approach and the acquisition of AT&T (NYSE:T)'s wireline assets in Connecticut. I believe FTR has been taking the right measures to strengthen its subscriber base and support its revenues by focusing on its core business operations. Also, the company offers a high dividend yield of 6.6%, which is supported by its healthy cash flows; the company's cash flows are likely to further improve as a result of T's wireline assets acquisitions. Moreover, the stock offers a potential price appreciation of 15% based on my price target of $7, as shown below.

Healthy Subscriber Base

FTR has long been focused on growing its broadband customer base in a highly competitive telecom sector by improving the quality of broadband services, in terms of both availability and speed, through simplified pricing policies. In the recent quarter, the company marked the 5th consecutive quarter of strong broadband momentum, with 37,200 net broadband additions in 1Q2014. Moreover, the company was successful in increasing its share in 91% of its markets being covered in the recent first quarter.

The broadband subscriber additions were positively affected by better speed and service quality. I believe that in the coming quarters, further deployment of broadband services to rural areas will hike up the subscriber momentum of FTR. The following chart shows FTR's net broadband subscriber additions in recent quarters.

Source: Company's Quarterly Earnings Report

Despite the fact that FTR experienced positive subscriber momentum in the recent quarter, total revenues were down 4.3%, negatively affected by lower CPE sales, carrier dispute settlements and wireless backhaul concerns. However, I believe the company, with its focused core business approach, will be able to moderate the revenue decline and outperform its peers. The recent price increase for Simply Broadband product from $29.99 to $34.99, network speed enhancements and higher costumer migration to higher broadband speed will portend well for overall revenue and ARPU growth for FTR in coming quarters. The following charts show the improvement in residential and business ARPU for FTR in 1Q2014 as compared to 1Q2013.

Source: Company's Quarterly Earnings Report

Margins to Improve

As the recent quarter's revenue base struggled despite the momentum in subscriber base, adjusted EPS for the quarter came out to be $0.05 flat year-on-year. I continue to believe that the acquisition of T's Connecticut wireline assets, which is likely to be completed in 2H2014, will help the company strengthen its wireline operations; FTR will benefit from expected annual synergies of $200 million, once the network integration is completed. Also, the acquisition will strengthen the company's core business operations and cash flows.

The company did experience a drop in EBITDA margin in the recent quarter, due to weather issues and payroll taxed; however, I believe the company will improve its margins in coming quarters due to cost control measures and expected synergies. The company currently has the highest EBITDA margin of 45% in comparison to CenturyLink's (NYSE:CTL) and Windstream's (NASDAQ:WIN) EBITDA margins of approximately 40% and 42%, respectively. The following chart shows the EBITDA margins trend for FTR.
(click to enlarge)
Source: Company's Quarterly Earnings Report

Dividends Balance Sheet

The company offers a strong dividend yield of 6.6%, backed by its solid free cash flow generation. The company has been consistently paying dividends; last week, FTR declared a quarterly dividend of $0.10 per share, flat quarter-on-quarter. The dividend is payable on 30th June 2014. FTR currently has a low dividend payout ratio of 43%, which indicates that the company has the option to increase its dividends by expanding the payout ratio. The company's cash flow base is further likely to improve as a result of T's wireline asset acquisition, as the assets have solid cash flow generation and they remain of high quality. The following chart shows the healthy comparison between FTR's cash flows and dividends.

Source: Company's Quarterly Presentation

The company's healthy balance sheet is another positive. FTR has a debt to equity of 2x, in comparison to WIN's debt to equity of 10x. I believe the company's financial strength remains healthy and the company will not have any issues in repaying long-term debt in the near term, as there are no significant debt maturities in the years ahead. The following chart shows FTR's debt maturity profile.

Source: Company's Quarterly Presentation

Price Target

I have used cost of equity 7.6%, after tax cost of debt 4.5%, WACC 6% and a nominal growth rate of 2.5% in my price target calculations. Based on my price target calculations, the stock offers a potential price appreciation of 15%.

2015

2016

2017

Terminal Value

FCF (In $-Million)

742

627

538

15,756

Present Value (In $-Million)

700

557

452

13,219

Source: Equity Watch Calculations and Estimates

Total Value of Firm = $700 + $557 + $452 + $13,219

= $14,928

Value of Debt = $8,130

Number of shares Outstanding = 994.03

Total Value of Equity = $14,928 - $8130

= $6,798

Price Target = $6,798/994.03

= $7

Conclusion

FTR has been making decent progress with its efforts to strengthen its subscriber base and improve ARPU, despite the intense competition and secular changes in the industry. The acquisition of T's wireline assets will not only help FTR strengthen its core business, but will also improve the company's cash flow base and result in cost synergies. Analysts are also expecting a robust next five years growth rate of 13%. Also, the stock remains an attractive investment option for dividend-seeking investors, as it offers a high dividend yield of 6.6%. Moreover, the stock offers a potential price appreciation of 15%, based on my price target of $7. Due to the above-mentioned factors, I am bullish on the stock.

Source: Frontier Communications: Efforts To Deal With Competition And Secular Changes In Industry Pay Off