Telecommunications are offering some of the highest dividend yields in the market, providing a potential haven for risk-averse investors. As I argued earlier, AT&T (T) is both a safe and undervalued investment with a rough intrinsic value of $36. This implies more than a 25% margin of safety that comes on top of a staggering 6.06% dividend yield. In the analysis, I further detail why the company's capital allocation policy is safe.
CenturyLink (CTL) is, in my view, both less undervalued and more risky than the Street will have you believe. Overall, in my view, its story is much of a mixed bag. From a multiples perspective, it trades at the high end of the peer group. The firm is valued at a respective 20.7x and 14x past and forward earnings, while AT&T and Verizon (VZ) are valued at only a respective 14.4x and 14.5x past earnings.
In addition, CenturyLink is also the most leveraged, judging by net debt to market value: 92.4% compared to AT&T's 36% and Verizon's 43.1%. The payout ratio (TTM) is also the highest amongst peers: 158% compared to AT&T's 87% and Verizon's 94%. Add a massive Qwest acquisition and you have some pressing concerns over the sustainability of current dividend distributions.
With that said, CenturyLink is viewed as the most undervalued of the three by analysts. The Street currently rates it near a "strong buy," versus a respective "buy" and "hold" for AT&T and Verizon. Depending on your level of confidence in Wall Street analysts, this can be either taken positively or negatively. On one hand, it's nice to have the authority on your side. On the other hand, this certainly sets the bar high and makes expectations harder to beat. I find that the second, however, is not so much of an issue in this instance, because management has a record of giving conservative guidance, and because prior Street expectations for EPS have mostly aired on the low side. Indeed, EPS estimates were so low before that they went up a staggering 63% after the company showed promise during the third quarter.
At the recent third quarter earnings call, CenturyLink's CEO, Glen Post, noted a much needed improvement in performance:
"Our results were solid for the quarter as we continue to invest in key areas of growth, meet our integration objectives and build positive momentum in a number of areas across our business in what continues to be a challenging economy and very competitive environment...
Third quarter diluted earnings per share, excluding special items, were $0.34 at the top end of our guidance and reflect the full noncash impact of purchase accounting rules related to the Embarq, Qwest and Savvis transactions… [P]ro forma adjusted diluted earnings per share... were $0.61 for the third quarter and exclude certain noncash purchase accounting adjustments".
CenturyLink has been a successful growth-through-acquisitions story in the past and I expect this to be the same way in the future. Qwest (Q) and Savvis (SVVS) contributed $2.7B and $223M, respectively, to the third quarter operating revenues of $4.6B - almost two-thirds of the total. While Savvis adds an exciting high-growth cloud services segment to the package, Qwest provides penetration into an urban market.
In the third quarter, strategic revenues grew by 5% to $2B and positive trends emerged in Internet and access line. In particular, the company slowed its losses in access line and saw 57,000 additions to its high speed internet basis -- a tremendous acceleration over last quarter. Free cash flow generation was also strong at $891, beating expectations.
Going forward, I am optimistic that an announcement about IPTV markets will be made earlier than expected to boost value. This is nevertheless a more risky area that the company is exploring and caution is advised. The Qwest merger -- which followed 6 consecutive quarterly declines in the top-line - will likely yield most of its revenue and cost synergies around early 2012. As CenturyLink has been a mostly rural provider, this addition will help expand market share and reduce volatility.
Consensus estimates for EPS are that it will decline by 21.5% to $2.66 in 2011, decline by 1.1% in 2012, and then increase by 0.8% in 2013. Of the 20 revisions to EPS, the vast majority, 18, have gone up. Assuming a lower multiple of 15.5x and a conservative 2012 EPS of $2.55, the rough intrinsic value of the stock is $39.53. This implies less than a 10% margin of safety and thus, in my belief, the stock does not meet the standard criteria of a value investment. In conclusion, while the company has a strong brand and is expanding into promising areas, the "strong buy" rating on the Street is overly optimistic. There are concerns to the sustainability of the 7.86% dividend yield, but considering the limited extent to which it could be reduced, it still remains an attractive income investment.
Click here for my analysis on AT&T and here for my analysis on Verizon.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.