Frontier Communications: Will The Rally Last?

Sep. 4.12 | About: Frontier Communications (FTR)

Frontier Communications Corporation (NYSE:FTR) has shown a resurgence in the past three months with strong shareholder return, even relative to the market and other leading telecom stocks like AT&T Inc. (NYSE:T) and Verizon Communications (NYSE:VZ) and the broader S&P 500 (SPDR S&P 500 Trust ETF: SPY). The following table shows the total returns over select time periods.

Total Returns of Select Telecom Stocks
Ticker Name 3 Month 1 Year 5 Year
FTR Frontier Communications Inc. 35% -29% -39%
CTL CenturyLink, Inc 14% 30% 48%
WIN Windstream Corporation 10% -15% 23%
VZ Verizon Communications Inc. 6% 26% 72%
T AT&T, Inc. 9% 37% 59%
SPY S&P 500 Index Trust ETF 11% 19% 21%
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Source: Yahoo!Finance for pricing information. Returns include dividends as well as price appreciation/depreciation.

So while Frontier Communications has posted a great performance over the past three months, its longer-term returns have significantly lagged the market, despite very robust historical dividends. The key question is whether or not this rally will continue and help longer-term shareholders recover some of their capital losses.

Solid Second Quarter News

I was somewhat surprised at the second quarter results that had some good points that offer promise for current FTR stockholders. The earnings were released after hours on July 31. The following day the market closed up 11% from the previous close. Since then it has tacked on another 7%. The first point was the performance on a unit basis. It appears that some benefits of the cost cutting and synergy capture are finally, albeit behind schedule, starting to take hold.

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Source: SEC Filings and author calculations. Note that all costs and revenues, including revenue and costs from High Speed Internet and Video services, are distributed across access lines.

One can see that while revenue is up and costs are down, the spread has not yet returned to the pre-acquisition level. However, this is the promising trend for Frontier Communications and one that investors should focus on in upcoming quarters.

Fundamental Challenges remain for Wireline Industries

Frontier Communications operates in a relatively challenging market with strong fundamental pressures from mobile and consumer behavior. The following chart shows the quarterly revenue since its acquisition of VZ's assets.

Source: SEC Filings

The chart shows slow and steady quarter over quarter declines. Declining revenue creates continued pressure to reduce costs in order to maintain the same level of profitability. This is especially challenging for a business that has relatively low variable costs and very high fixed costs. However, this is still largely true of VZ and T. The difference is that T and VZ have pursued wireless communications and captured the benefits from that trend. One would surmise that this is why their longer term returns are stronger than those of CenturyLink, Inc. (NYSE:CTL), Windstream Corporation (NASDAQ:WIN) and FTR which have oriented their business models around fixed line telephony.

The overall decline in revenue is driven by a consistent defection of access line customers without sufficient gains in video and high speed internet. The following table shows the quarter on quarter changes in the four segments: residential access, business access, high speed internet, video:

Quarterly change in subscribers
Time Period Residential Business High Speed Internet Video
Q2 2012 -2.1% -1.3% 0.3% 1.1%
Q1 2012 -2.2% -1.6% 0.7% 0.8%
Q4 2011 -2.3% -1.5% 0.5% 0.2%
Q3 2011 -2.5% -1.5% 2.3% 0.4%
Q2 2011 -2.6% -1.3% 0.4% 1.4%
Q1 2011 -3.1% -1.1% 0.6% 2.8%
Q4 2010 -2.7% -1.4% 0.3% 3.1%
Q3 2010 acquisition acquisition acquisition acquisition
Q2 2010 -2.0% -0.6% 0.5% 2.2%
Q1 2010 -2.0% -1.0% 1.3% 1.6%
Q4 2009 -1.8% -1.1% 2.4% 5.1%
Q3 2009 -2.2% -0.9% 1.2% 4.6%
Q2 2009 -1.5% -0.7% 2.3% 7.8%
Q1 2009 -1.9% -1.3% 3.5% 21.8%
Q4 2008 -2.1% -1.4% 1.4% 6.7%
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Source: SEC Filings, Author calculations based on Q-on-Q changes.

So the latest changes in access lines and subscribers show some slight positives for access lines with residential access line declines at a post acquisition low and business lines near post acquisitions lows. However, these numbers are still higher than pre-acquisition performances suggesting a challenged market. However, while high speed internet (HSI) and video subscribers grow, the pace of the growth for HSI was at a post acquisition growth. Video showed a more promising result with higher rate than in previous quarters.

Conclusion

Despite this recent surge in the stock price, which has possibly chased some short sellers out of the market, I remain very skeptical about Frontier Communications. The fundamental trends are not promising for this company. FTR continues to lose access line customers across both residential and business segments every quarter. I do not expect the rally to last.

If I were a long, I would look at the unit metrics once the Q3 2012 10-Q filing comes out. This will be a critical point to see if underlying unit metrics improve again. Unit improvement will be critical to sustain financials as I suspect the defection of subscribers will continue. Long term, this raises significant questions of viability; however, in serving many rural markets, FTR might eventually hit a buffer point where subscriber defections decline. This type of trend is present in the data and in particular in the residential data for access line subscribers on a post-acquisition basis.

If I were an investor who went long looking to capture a bounce play, I would consider exiting this stock. I would not consider initiating a new long position due to the macro downward trends against Frontier Communications. A more detailed analysis might suggest some potential for a value play, but I would be surprised by that. Despite a nice current dividend yield of 8.7%, I would not consider this a good income opportunity.

Disclosure: I am long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.