At first glance, two things should stand out about CenturyLink (CTL): its great dividend and its unbelievably high payout ratio. Currently, CenturyLink shares yield a 7.3% dividend, which is outstanding. At the same time, the company is paying out 333% of its income. A third grader could tell you this doesn't add up, so why are people still buying CenturyLink?
A closer look at the company's recent reports helps to clarify things. CenturyLink had a very active 2011, in which it acquired both Qwest and Savvis. Both acquisitions were paid for with stock, which doubled the company's shares outstanding. The markets were not initially happy about these transactions and CenturyLink shares sold off extensively from June to August of 2011.
The main reason for this decline was fears about the high costs of integrating the new acquisitions. Shares have since rebounded based on the company's fiercely maintained dividend more so than great earnings. Throughout these acquisitions, CenturyLink has continued to offer $2.90 in annual dividends regardless of share price or earnings. Investors must love this and hate this at the same time. For sure the dividend is great, but should it go away, the stock would collapse. As it is now, the lowest the stock could go with that dividend is $29. There is no way a company like CenturyLink could offer a 10% dividend yield and not have buyers. This is only true if the company maintains the current dividend.
Starting with the company's annual report and continuing with last week's first-quarter report, many of these fears went away. The first clues came with the company's annual report. Depreciation and Amortization costs for the company have been exceedingly high since the aforementioned acquisitions. These figures have been inflated because the company decided to amortize the labor expenses resulting from the company's integration with Qwest and Savvis, as well as accelerate the depreciation of some infrastructure assets. The result is very low reported earnings and more reasonable adjusted earnings.
While the company is still paying out more in dividends than it is earning, even via adjusted earnings, the adjusted payout ratio is closer to 100% rather the previously mentioned absurd figure of 333%. A closer look at the cash flow statement paints an even better picture. The company's reported net income for the first quarter of 2012 was $200 million. Dividend payouts total $452 million. However, after depreciation is removed and other adjustments are made, the net cash flow from operating activities was $1.583 billion or $2.55 per share. This represents a much healthier business than is portrayed by the income statement. Furthermore, the company recently issued $2.032 billion in new debt to shore up liquidity and refinance old debt.
The results that were reported last week further addressed many of the concerns investors were having with the company. Is the aggressive acquisition strategy going to pay off? Is the company going to be able to maintain its strong dividend? And are earnings going to show up eventually to justify the company's current share price? Without a doubt, this first quarter report answered a definitive yes, yes, and yes. Adjusted earnings came in at 68 cents a share, which topped analyst estimates and caused analysts to increase expectations for the future.
As an investor the main reason this was a good report is because it indicated the company's dividend would remain firm because the company is making enough cash flow to maintain it. With a dividend like CenturyLink's, any capital appreciation is simply icing on the cake. CenturyLink offers a substantially better dividend than other telecom companies like Verizon (VZ) at a 4.86% yield and AT&T (T) at a 5.24% yield. These companies all trade for similar forward multiples and command similar net profit margins. The difference is Verizon and AT&T both have substantial mobile components while CenturyLink does not.
CenturyLink's main offerings are broadband and landline telephone services in rural markets. The rural market penetration is a plus and is the main competitive advantage for the company. However, landline telephones may as well be dinosaurs. With the prevalence of cell phones and new technology available from companies like MagicJack and Skype now offered by Microsoft (MSFT), landlines really are not competitive anymore.
For an individual with a cell phone and home internet, landlines are just too expensive to compete. For these reasons, the home telephone business is predicted to be a stagnant if not declining market. This does not bode well for CenturyLink's home telephone business, which is luckily just a small component of this company's overall business. In addition to broadband internet services the company is expanding to offer cloud hosting services as well, as part of the business segment acquired with Savvis. This is believed to be a higher growth industry.
As a total package, CenturyLink is a strong company and should make for a good investment. Based on the dividend alone, investors should be satisfied. The company's recent report lends confidence to the continuance of the dividend. Also, the strong report lends creditability to the management that looks to have successfully pulled off some large acquisitions within the last year and done so at lower than predicted integration costs.
The value of strong management cannot be measured and is one the strongest predictors of a company's success. Based on the management's recent performance and the company's outstanding dividend, CenturyLink is a company value investors should be buying.