By Ishtiaq Ahmed
It is often the case that shareholders have to give up short-term gains for long-term benefits. This is exactly what happened with Frontier Communications (FTR) shareholders when the company announced its first dividend cut. It was not easy for Frontier to triple the size of the company and maintain the same levels of dividends. Growth through acquisitions usually comes at a cost. In Frontier's case, the income hunting investors paid the price. Aggressive acquisitions saddled the company with massive debt levels and weak cash flows. In addition, the integration and restructuring costs impacted the earnings of the company. However, the dividend cut was a necessary step, which the company had to take for the long term stability.
In my previous articles, I have done a thorough free cash flow and valuation analysis for Frontier. However, the debt levels of the company have always intrigued me, and I wanted to know whether the dividend cut helped the company or not. Frontier claimed that the savings from the dividend cuts will help the company manage its debt load. I decided to perform a debt analysis based on some essential ratios for Frontier before and after the dividend cuts. The firm cut its dividend from the third quarter of 2010, so I have used 2010 as the base year and used the second quarter 2012 earnings report as the current report. In addition, I have added the debt raised by the company during the third quarter of 2012. My calculations gave me following results.
After the Dividend cut
Before the dividend Cut
Asset Coverage Ratio
Debt Service coverage Ratio
Debt to EBITDA
Interest Coverage Ratio
Data taken from SEC filings
I believe these six ratios are an excellent tool for debt analysis. I will now discuss the mechanism and the results of each ratio briefly.
This ratio measures the ability of a company to cover its debt obligations with its assets. The ratio tells how much of the assets of a company will be required to cover its outstanding debts. In 2010, Frontier asset coverage ratio was in an extremely poor condition (a ratio between 1.5 and 2.0 is considered safe for the industry). However, the ratio has improved significantly in 2012 and is currently in line with industry standards. In 2010, Frontier had debt of just under $5 billion and assets of $6.8 billion. However, after adjustments for intangible assets (goodwill), Frontier assets came down to just above $4 billion. As a result, the company assets gave poor coverage.
The capitalization ratio compares total debt to total capitalization (capital structure). The capitalization ratio reflects the extent to which a company is operating on its equity. Capitalization ratio has also improved substantially for Frontier. The total debt for the company increased over the two years and went close to $9 billion. However, total debt as a percentage of total capital came down to 64%.
Debt ratio indicates the proportion of a company's debt to its total assets. It shows how much the company relies on debt to finance assets. Over our analysis period, Frontier has improved its debt ratio considerably. In the base year, the ratio stood at almost 96%, which means almost all of the assets were financed by debt. However, the ratio has now come down to 75%, and further improvement can be expected with the savings from dividend cuts.
Debt Service and Interest Coverage:
Debt service and interest coverage ratios show the ability of the company to meet its debt obligations. For Frontier, the debt service coverage ratio has increased, but the interest coverage ratio decreased. I believe the interest coverage ratio will also improve once the company gets rid of integration and restructuring costs. At present, integration and restructuring costs are a burden on the operating income of the company. Even at current levels, interest coverage ratio indicates sufficient coverage for the company. However, for our analysis purposes, the ratio shows a decline over the period being analyzed.
Debt to EBITDA:
Debt to EBITDA ratio is an extremely important metric. This metric used by rating agencies as well as financial institutions in order to extend credit. Debt to EBITDA has improved for Frontier and currently stands at 3.93. This improvement in debt to EBITDA will give Frontier financial flexibility. This is also evident from the recent borrowing by the company, and the credit facility the company established recently.
Although Frontier is one of the most broadly followed telecommunication stocks, it is hard to compare with telecom giants. I think it would be fair to state Windstream Corporation (WIN), Alaska Communications (ALSK) and Consolidated Communications Holdings (CNSL) as related companies. There are also some regional competitors for Frontier, which are limited to smaller regions.
Debt to Equity
In comparison to its competitors - Frontier is cheaper based on P/B and P/S ratios, while it is a little expensive on the basis of P/E ratio. However, Frontier has stronger margins as compared to its competitors. On the other hand, some of its competitors offer attractive ROE at the cost of elevated debt and risk levels.
Out of these three, Windstream is the biggest competitor for Frontier. Windstream has over 3.2 million customers in sixteen states. While its current yield of 9.9% is higher than Frontier's yield of 8.2%, the danger of a dividend cut remains for Windstream.
High dividend yields are extremely attractive in present day low interest rate environments. However, Frontier took a difficult step to improve its debt situation which looks to have paid off. My analysis shows that almost all metrics for Frontier show an improvement since the first dividend cut. As a result, the company now has financial flexibility to deal with its operations. In addition, improved debt metrics will allow the company to negotiate favorable terms for future borrowings. I believe Frontier has a bright future ahead now that it has tacked its debt and to some extent integrated the acquisitions.