Over the past couple of years, Frontier Communications (FTR) has lived up to the worst-case scenario for high-yield stock investments. The yield was at double-digit rates on fears of a dividend cut, then when the dividends were reduced, the share price dropped again to bring the yields back into double digits.
Along the way, the dividend was cut by 60%, and the share price is down 65% from the late 2010 peak. The Frontier management has been pushing a scenario that when the integration of the big 2010 acquisition of rural telecom services from Verizon (VZ) is complete, the company will be in a position to again grow revenue, free cash flow, and dividend. Over the last two years, the costs of integrating the Verizon states and the steady bleed off of telephone customers has led to a steady erosion of revenue and cash flow.
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Now, in the second quarter of 2012, Frontier Communications has completed the integration of the acquired Verizon customers on Frontier's own systems; the company management is positive it can start providing a positive return to shareholders. The backbone of the plan to increase EBITDA is to increase penetration of Frontier's broadband Internet services to residential and business customers, along with increasing the revenue from existing telephone customers as they upgrade to multi-product packages. Company management believes the flexibility of its systems and attention to customer service at the local level gives Frontier a competitive advantage when selling its telecom products.
If you spend some time listening to any of the earnings reports or presentations from Frontier executives, you get the feeling that the people running this company believe strongly in what they are doing and the ultimate success of their plans. These beliefs tend to bleed over to investors, many whom have been patiently waiting for the expected turnaround and recovery of past values and dividend rates. It is easy to buy into the story Frontier management sells, but a skeptical look at some factors make a big recovery in the stock price seem less likely.
Back in August 2010, when the quarterly dividend was reduced from 25 cents per share down to 18.75 cents, the company stated the new dividend rate was "an attractive and sustainable payout ratio." At that time, the new dividend was 55% of available cash flow. However, six quarters later, the dividend was reduced by 45 percent when the shrinking cash flow would no longer support the payout. Since the new, lower dividend rate was declared in February, the Frontier share price has declined by one-third, bringing the yield back up to 11%. This is not the yield the stock market puts on a stock with positive expectations.
Frontier faces very formidable competition in its quest to grow revenue through the expansion of the broadband customer base. The primary competition is from the cable companies operating in the same areas as Frontier. The two major competitors are $80-billion Comcast (CMCSA) and $24-billion Time Warner Cable (TWC). It remains a serious question whether $3-billion market cap Frontier can compete with these large cap competitors just on the promise of better customer service. Frontier can pick up additional per customer revenue by bring better high-speed access to its rural telephone customers, but the current Frontier broadband offerings in towns and cities do not have a speed or value advantage over the cable company offerings.
In the face of the company's need to turn around declining revenue and customer number trends, the current 11% dividend yield does not make Frontier an attractive investment candidate. Prospective investors should wait and see if the company can actually live up to its promises for the rest of 2012 and into 2013. An increase in the dividend rate would be a good sign that results are improving for Frontier Communications.
Additional Reading: Comcast Poses A Danger to Some Favorite High Yield Stocks
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.