Solid Results From CenturyLink

| About: CenturyLink, Inc. (CTL)

Typically a company that reports an improved annual rate of revenue decline would not interest this investor. CenturyLink (NYSE:CTL) though offers a compelling 6.9% dividend yield and strong free cash flows to offset that revenue decline.

Per the press release, the company is the third largest telecommunications company in the U.S. and a global leader in cloud infrastructure and hosted IT solutions for the enterprise customers.

In reality though, the company is still composed of a legacy wireline business that is in decline. Along the way to total annihilation, the company has been able to maintain a considerable amount of the wireline base while also dramatically reducing costs. Not to mention acquiring growth companies such as Savvis that provides growth opportunities.

To my surprise, CenturyLink maintains a quarterly revenue base of over $4.6B and a market cap of over $26B. Not to mention guidance for free cash flow that tops $3.2B this year making it a serious competitor in the communications sector.

Q2 Earnings Highlights

The company reported Q2 earnings that topped analyst estimates while revenue was inline. These numbers are about what investors would want from a high yielding stock. Below are some of the main highlights:

  • Improved year-over-year actual-to-pro forma revenue trend to a 1.2% rate of decline (1.7% rate of decline excluding data integration revenue), compared to a 3.8% decline in pro forma second quarter 2011.
  • Achieved free cash flow of $779 million, excluding special items and integration-related capital expenditures.
  • Reduced access line loss by 22% as the line loss trend improved during second quarter 2012 to a 6.1% annual decline compared to a 7.4% annual decline in pro forma second quarter 2011.
  • Added more than 18,000 high-speed Internet customers reflecting expected second quarter seasonality; ended second quarter 2012 with 5.76 million subscribers[3].
  • Expanded the number of Prism™ TV subscribers by 11% in second quarter 2012 from first quarter 2012 and increased penetration of available homes in our markets to more than 9%.
  • Generated sequential recurring revenue growth in our Enterprise Markets Group's Network Services and Data Hosting Services, along with strong bookings in both operating groups.
  • As of June 30, 2012, we had more than 50 data centers[4] in North America, Europe and Asia, with total sellable floor space of approximately 1.4 million square feet.

Though CenturyLink continues to lose access lines it was able to add 18,000 broadband customers and grew TV customers by 11% sequentially to offset those declines. This continues to lead to year-over-year revenue increases in broadband and hosting services.

Free Cash Flow

The biggest issue most investors miss when evaluating a company is that the key to a company's performance are the difference between revenues and expenses or the gross margin and operating margin. Too many times investors focus too much on revenue growth solely.

A company growing revenue extremely fast while also growing expenses should be no more attractive than a company with no growth that is able to reduce expenses faster.

CenturyLink falls into the later category but continues to be able to maintain strong free cash flow of $779M in the last quarter alone. This number was down compared to the roughly $1.07B reported in the prior year.

While operating cash flows remained virtually the same year-over-year, the free cash flow saw a significant decline due to higher interest and cash tax expenses.

The main driver of the solid free cash flow is that the depreciation charge of $1.2B was substantially higher than the $609M spent on capital expenditures. As long as this pattern remains, CenturyLink should continue throwing off excess cash.

Dividend Safety

The dividend is currently over 50% of free cash flow for the first six months of 2012. This provides some safety for maintaining this rate for now. The company needs to reduce interest expenses or figure out how to stabilize revenues in order to maintain this rate long term.

Risk

The risks in the telecommunications industry might be some of the best known in the market. Wireline providers and services will quickly be replaced by wireless services. Right now companies such as CenturyLink are able to slowly add data customers.

If wireless ever became a viable alternative to either broadband or video, this company would face considerable problems as existing systems become obsolete. That's an even bigger issue as the company has debt exceeding $21B.

Valuation

The stock appears expensive based on earnings expectations alone. Based on the free cash flow though, the stock only trades at roughly 8x the updated guidance for 2012. With a solid 6.9% dividend, this stock appears slightly cheap especially for anybody looking for a solid yield.

Conclusion

With interest rates at historic lows, this company makes an attractive investment option. This is especially true considering most other high dividend sectors such as utilities have risen so much that dividends are now considerably lower than that of CenturyLink.

As pointed out in a previous article, Frontier Communications (NYSE:FTR) actually provides a more appealing dividend with better free cash flow coverage. Investors might want to consider that stock first. Both companies provide compelling investments along with Windstream (NASDAQ:WIN) that yields 10%. It reports prior to the open on Thursday so investors should be able to compare all three by then.

At this point investors probably won't go wrong in the sector. The best option might just be to invest in which company trades at the cheapest multiple to free cash flow.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Please consult your financial advisor before making any investment decisions.