- WIN’s broadband internet shows signs of recovery despite numbers being negative.
- Business revenue has lost momentum.
- Investors continue to enjoy high yield, but risks of elevated payout ratio remain a concern.
Windstream Holdings, Inc (NASDAQ:WIN) is an incumbent local exchange carrier that provides local communication and entertainment services, primarily to small and rural markets across 16 states. I am neutral on the company because it continues to remain highly leveraged with an unsustainable dividend yield. Furthermore, the growth in business revenue is slowing down and the increase in broadband revenues is not sufficient to compensate for declining consumer revenues.
Although broadband net adds in Q1'14 were better than 11k-12k declines in 2013, the company has not yet been able to leverage its network to expand its broadband and television subscriber base; whereas its peers CenturyLink (NYSE:CTL) and Frontier (NASDAQ:FTR) are attracting a lot of customers in this segment. I believe that WIN will continue to show the improved performance in 2014, as it will be finishing the network expansion to 75,000 new households.
WIN also lost 7.5% of its business customers, which contributed nearly 62% to total revenues. This loss was primarily driven by -8.5%YoY losses in small business locations. Enterprise continues to perform better as its customer locations improved by 2.5% YoY.
Earlier this month, WIN's management presented at the Stephens Spring Investment Conference. Bob Gunderman, the senior vice president of Financial Planning and Treasurer, said they have plenty of room to grow organically without acquisitions. It is true given that their market share is low, but competition is also very intense out there and consumers are moving rapidly towards wireless services. I think it will not be possible for WIN to show any significant improvement in its revenue base in the near future.
WIN also has limited options to raise money for its future M&A. If the company issues new stocks, it would be difficult for the management to maintain dividends at $0.25 as the payout ratio is already very high. Eventually, the dividend yield will decline and it will cause panic among shareholders. The company has no short-term maturity, but it is highly leveraged with a debt-to-equity ratio of 1204x, which is higher than both CTL and FTR. It means that WIN has limited room to finance its growth by taking more leverage.
The company needs to give up its dividend-centric strategy to save money and allocate funds to drive long term growth. In the last five years, CTL has dropped its dividends to $0.54 from $0.725 and FTR has reduced its dividends from $0.25 to $0.10, whereas WIN has maintained its dividends at $0.25. This strategy has elevated WIN's payout ratio as shown in the table below. WIN offers an attractive yield but its high payout ratio along with weak corporate performance maintain unconvincing outlook for the company.
Free cash flows (CFO-Cap exp)
Dividends/ Free cash flows
Source: Company Data
The company's share price has gone up by 27.22% YTD and it is currently trading right at the top end of its 52-week range. This growth was primarily driven by the possibility that the Senate might renew The American Taxpayer Relief Act of 2012. This act will allow WIN to get the rebate in cash taxes of approximately $100 million in 2014 and 2015. However, this is uncertain and the Senate will be making a decision later in the year. I believe the Senate might rule in favor of the telecommunication company to manage the unemployment rate, which is currently very high, to support economic growth especially after the 1% annual GDP reduction in 1Q'14. But the important thing for investors to understand is that the risk remains as it is not a done deal and it can go either way.
My price target of $8 is based on the 6x expected 2015 EV/EBITDA as shown in the table below. Therefore the company is overvalued.
Expected 2015 EBITDA
Enterprise value=$13,530 million
Total Debt= $8,706.3 million
Total Value to firm - Total Debt = Total Equity value
$13,530- $8,706.3= $4,823.7 million
Share Outstanding = 602.7 million
Target Price = Total Equity Value/Share Outstanding
$8 = $4,823.7/602.7
WIN's broadband internet is showing signs of a recovery but still the numbers are negative. Business revenue, which is a key growth driver, has lost its momentum. Investors continue to enjoy the high yield, but risks of elevated payout ratio remain a concern. It needs to cut down on its dividend-centric strategy and save some cash to bring down the leverage and enhance future growth opportunities.