CTL has shifted focus from dividends to investing in new projects.
Stock remains attractive for income-seekers with high dividend yield.
Growth in broadband and video services will offset declining traditional voice revenues.
The telecommunication sector has gone through significant changes, as consumers shift from traditional voice to data services. Big telecommunication giants have benefited from the change in consumer preferences due to technological innovation. However, rural local exchange carriers like CenturyLink (NYSE:CTL), the third largest telecommunication company in the U.S., did not diversify to wireless services and continues to offer wireline voice services, which is a significant part of its revenue stream. Also, it offers high speed internet, TV, managed hosting and cloud services.
Like other RLECs (rural local exchange carrier), CTL is focused on offsetting its declining traditional legacy revenues through the growth in high speed internet and Prism TV customers. In the recent past, CTL managed to deliver a strong performance, which was driven by growth in strategic revenue and a slowdown in the decline of legacy revenue.
In the recent quarter, CTL added 66,000 new broadband customers, while the loss in access line customers was 5% YoY. I expect this broadband momentum to continue because there are significant future growth opportunities available in legacy Qwest markets and new Prism markets. Furthermore, the company is planning to enhance its scale by extending its fiber to more and more areas so that incremental third party costs can be avoided; these are incurred to provide network services to customers. The basic focus of the company is to improve and increase its network capability so that its sales force can market its high quality services to a large number of people. Currently, the company has 240,000 miles of fiber network and nearly 40% of broadband subscribers can enjoy speeds of 20megs or better.
The company's future acquisition will be targeted to build a strong network and increase its fiber rather than acquiring companies to get a hold of their subscribers. It will also look for attractive opportunities in the space of data centers.
Its peer companies like Frontier (NASDAQ:FTR) and Windstream (NASDAQ:WIN) are also following the same strategy. FTR reported a record number of broadband net adds of 37,000 in the first quarter of the year, whereas the loss in access lines was 5.9% YoY. FTR is in the process of raising $1.9 billion to buy the Connecticut wireline operations from a large telecom giant. It is expected that this will add almost 450,000 data and 900,000 voice customers. It will also help enhance EBITDA by $525 million if all synergies are included. So, the company has been able to build solid subscriber momentum.
WIN broadband has shown signs of improvement, but for the first quarter of the year, the losses in broadband net adds were minimal, which were better than the 11k-12k declines in 2013. The reduction in voice customers was 6% YoY. I am expecting a modest improvement in the broadband trend when the company finishes its network expansion to 75,000 new households this year.
A high dividend yield is an important growth driver for these rural local exchange carriers, and dividend cuts could have a drastic impact on their price. CenturyLink offers the lowest dividend yield, as shown in the table, but I believe it has the most sustainable yield, as its dividends to free cash flow ratio is the lowest amongst its peers. The company is targeting its payout ratio to be 60% of free cash flows after it became a full taxpayer, whereas its peers are currently paying 60% or more in the form of dividends. FTR's dividends to free cash flow ratio is at a manageable level and there is no imminent danger of dividends reduction. However, WIN, on the other hand, pays a handsome dividend yield, but it is not safe and I am expecting a dividend cut that will allow the company to save money to utilize in growth projects.
Free cash flows (CFO-Cap exp)
Dividends/ Free cash flows
Source: Company Data
Since the inception of the share buyback program in February, 2013, CTL has repurchased 58.7 million shares costing approximately $1.97 billion, equal to 9.5% of the total outstanding shares. These share buybacks have helped the company reduce its dividend bill by approximately $126.8 million annually, assuming the current annual dividends of $2.16. On the other hand, FTR and WIN are not undergoing any share buyback programs.
CTL has been able to manage its debts effectively with the lowest debt to equity and interest coverage ratios. FTR and WIN are generating sufficient EBIT to cover their interest payments, which means there is no imminent danger of bankruptcy. The worrying sign is the high total debt-to-equity ratios of the companies, especially WIN's. It limits the ability of these companies to grow by raising debt as they operate in a capital intensive industry. Other option includes the issuance of new shares, it will decrease its yield, which will reduce its share price as these companies are very sensitive to dividend cuts.
Total debt to Equity
Interest coverage Ratio
Currently, these companies are trading at the top-end of their 52-week ranges because of the possibility that the Senate might renew The American Taxpayer Relief Act of 2012. The actual decision will happen later in the year, and if the decision does not go in the favor of telecom companies, investors should expect a pullback if it is not backed by a strong corporate performance.
CTL has rightly given up its dividend-centric strategy and invested in several new projects to compete more aggressively and gain a market share. It continues to remain attractive for income-seekers with its high dividend yield and sustainable dividend to free cash flow ratio. Traditional voice revenues are constantly declining, but the growth in broadband and video services will more than offset these pressures. I believe CTL is the best placed among RLECs.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.