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Summary

  • Frontier Communications has huge debt and its earnings are expected to decline in the next five years, so it might be forced to cut its high dividend yield.
  • Frontier, however, is making aggressive investments to improve its business, and is gaining market share in its end-markets that could lead to long-term growth.
  • Frontier's cash flow generation is strong, and this should help the company in paying out its dividend going forward.

Although Frontier Communications (NASDAQ:FTR) is up close to 25% this year, the company's last-reported first-quarter results were not up to the mark. Frontier missed estimates on both revenue and earnings, even though it gained broadband market share in 91% of its markets. Moreover, Frontier's revenue was down 4.3% from the year-ago quarter, while its earnings dropped 18.4% year over year.

Investors are attracted toward Frontier because of its eye-catching dividend yield of 7%. However, if Frontier is unable to improve its revenue and earnings significantly going forward, then its dividend might take a hit. In fact, Frontier's current dividend yield of 7% is lower than the five-year average yield of 10.7%, so a dividend cut cannot be ruled out. Additionally, the company has a payout ratio of a massive 400%.

Why the dividend might be cut

Analysts aren't optimistic regarding Frontier's performance going forward. According to estimates, Frontier's earnings are expected to drop at a CAGR of 20.5% over the next five years, which is greater than the decline of around 9% seen in the last five years. It also has a huge debt figure of $8.13 billion to contend with. In comparison, Frontier's cash position is relatively weak at just $954 million.

Hence, Frontier has to service a huge debt, so it is imperative for the company to improve its revenue and earnings in order to sustain the high payout ratio. Moreover, Frontier is an expensive proposition at close to 60 times last year's earnings. But, it looks like Frontier is making some positive moves to improve the business.

Trying to improve

The first-quarter numbers may look quite disappointing, but Frontier's management has a different view on this. According to Maggie Wilderotter, Frontier's Chairman and Chief Executive Officer, "We are extremely pleased to report that the strong momentum we experienced in all four quarters of 2013 continued in the first quarter of 2014." During the quarter, the company reported broadband net additions of more than 37,000 users, which is a new quarterly record for the company.

Frontier is trying to put the disappointment of a weak earnings performance behind it, which it attributed to certain carrier settlements and lower voice revenue. Moreover, the sale of customer premise equipment (NYSE:CPE) was also down during the first quarter, which added to the revenue decline. Although CPE is only a small portion of Frontier's overall business, but it is important because it allows the company to deepen its relationship with customers and results in monthly recurring maintenance fees. Looking forward, the company is positive about its prospects as monthly recurring revenue is expected to remain stable, along with growth in data.

Network enhancements to drive growth

Frontier has completed the enhancement of network speeds in many of its markets. This will allow households and business organizations to upgrade to higher speed tiers that will ultimately increase its revenue. To improve its performance, the company launched its new Frontier Anywhere Hosted Business Telephone System for business organizations, which is already off to a strong start.

In addition, Frontier is focusing on its operating strategy, along with managing its cost structure. Frontier is focusing on broadband, which is the core of its product portfolio. The company has also partnered with various other organizations such as Crius Energy, Yahoo (NASDAQ:YHOO) etc., which will reduce its time to market for its new products and services.

Frontier is also positive regarding its acquisition of AT&T's (NYSE:T) Connecticut wireline business, and it has made good progress integrating it. According to management, "This transaction will create shareholder value. It is expected to be free cash flow accretive in the first full year and improves the security of our dividend by further reducing our dividend payout ratio in that first full year."

As reported on Forbes:

Frontier will receive approximately 415,000 data, 900,000 voice and 180,000 video residential connections of AT&T in Connecticut, as well as AT&T's local business connections and existing carrier wholesale relationships. This represents about $1.2 billion in annual revenue, or less than 1% of AT&T's total annual revenues, as of 2013. Frontier is paying AT&T $2 billion in cash for these assets.

Hence, Frontier seems to have made a good move by acquiring this asset as it will aid its long-term growth. Additionally, Frontier is introducing new features. For example, it has now become the first tier 1 operator to enable text messaging through a business landline number. According to a press release:

Frontier Communications Corporation today announced a partnership with Zipwhip, Inc. that allows its business landline numbers to become text messaging channels to advance business communications. Frontier Texting powered by Zipwhip gives businesses the ability to connect with customers who choose the convenience of text messaging as their preferred means of communication.

With Frontier Texting, Frontier customers can text, or receive a text from, a business' existing landline or toll free number. The message is then pushed at the same time to the business' Internet-connected devices, such as a laptop, desktop, smartphone, or tablet. A business user can then reply back from whatever device they're on using a Frontier Texting app powered by Zipwhip.

By offering a new feature, Frontier will be able to bring more business customers into its fold, and thereby improve its revenue generation opportunities.

Cash flow generation is strong

Frontier's strategies look impressive, and should help the company maintain a respectable dividend in the long run. In addition, the company's cash flow metrics are strong. In the last twelve months, Frontier has generated operating cash flow of $1.45 billion, while its levered free cash flow stands at $930 million. Coupled with positive developments in the business, strong cash flow generation will also help Frontier to sustain its dividend yield in the long run. So, investors should look beyond the short-term pain and focus on Frontier's long-term potential.

Source: Can Frontier Communications Sustain Its Dividend?