Confessions Of A High Yield Investor In Frontier Communications

 |  About: Frontier Communications Corporation (FTR), Includes: CTL, T, VZ
by: Norman Tweed

I retired in 2000 with the expectation of rocking away my golden years, while living off mutual fund dividends from my IRA. After market crashes in 2002 (-46% SPY) and 2008 (-52% SPY), that plan went by the wayside.

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I had always been a dividend growth investor outside of my 401k investments at work and I decided to enhance this portion of my investments with high yield investments. Over the years, I had invested in AT&T (NYSE:T) and Verizon (NYSE:VZ) in the telecommunications sector and after the spin off of Frontier (NASDAQ:FTR) from Verizon, I decided to keep it, even though previous spin offs from Verizon (FairPoint Communications and Idearc) had both ended in bankruptcy. Last fall after Frontier had fallen in price to $5.38, I decided to round up my shares to a full position (2% of portfolio). The yield at that time was 13.98%. The stock continued to crater and for the first quarter of 2012, they cut the dividend by 47% and the stock fell to $3.34.

Stock Date of reinvest Div Rate # Shares Dividend Drip price # Shares pur Total Value Current Yield
Totals 2,026.62 $738.58 167.89
06/06/12 $0.10 1,967.70 $196.77 $3.34 58.91 $6,768.90 11.98%
FTR 03/07/12 $0.10 1,923.68 $192.37 $4.37 44.02 $8,598.86 9.15%
12/07/11 $0.19 1,858.73 $349.44 $5.38 64.95 $10,349.41 13.98%
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After the most recent earnings report for second quarter 2012, there has been an upsurge in the stock price to $4.75:

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My question now is: "What is the fair value of Frontier?"

By using traditional valuation principles, I find that Frontier has a debt to total assets ratio of 74.8%, with 3.85% earnings per share growth projected for next year and 16.9% long term earnings per share growth (Yahoo finance and Thompson Reuters). The forward P/E is 15.7, while the trailing P/E is 21.9.

Traditional valuation for this stock is not too precise, considering the negative revenue growth and continuing loss of customers. In order to counter these trends, Frontier has been working on their balance sheet. They have reduced intangible and other assets and paid down accounts payable. Their financial leverage is still 3.97/1, but this improves their cash flow and earnings per share.

To me, it comes down to the question: "Can they maintain the dividend at $.10 per quarter or even raise it in the future?" If so, I would compare Frontier with CenturyLink (NYSE:CTL) which pays a 6.78% yield, rather than AT&T which pays 4.69%. AT&T ($217.63B) and Verizon ($127.06B) are both very large cap companies, while CenturyLink ($26.58B) is closer to a mid-cap company, like Frontier ($4.71B). With the recent rise in FTR price to $4.75, the yield has fallen to 8.42%. In the low yield environment that we find ourselves in, even the 30-year treasury bond yield has fallen to 2.73%. If the risk of a dividend cut from Frontier is in the same range as CenturyLink, I contend that the yield should be the same, or a stock price of $5.89 per share when treated like a bond with no growth. It is obvious that the market has not reached that conclusion, yet. However, we are well on our way to 8% yield or $5 per share, which I contend is a fair value today.

Conclusion: By purchasing a high yield telecom stock last fall, I was making a speculation. I considered at the time a 100% loss, similar to FairPoint and Idearc as a distinct possibility. In so doing and by dripping the shares on the way down, I was able to gather 5% additional shares in the first half of this year. I have nearly broken even on this investment. I plan to hold and drip it until it appears that they can't cover the dividend.

Retirees should be extremely careful about chasing yield. Regular investors should have some high yield stocks in their mix in order to improve overall portfolio yield. No investment should be made without exercising due diligence.

Disclosure: I am long FTR, T, VZ, CTL.