When comparing local telecom providers one name consistently stands apart from the rest, CenturyLink (NYSE:CTL). In one big way all local telecom operators are, at best, risky stocks given that their primary business is in an area that is clearly on the decline. Residential phone lines, or landlines, are seeing negative growth as more people and families rely solely on wireless phones. It is natural to wonder how these companies can survive into the future. However, when I look at a yield of more than 7% in a company, I immediately get interested enough check it out as any intelligent investor would be wise to do so. When I look deeper I see that of the three major local telecom providers only CenturyLink is poised to provide consistent reliable growth for investors. Let me explain what I found, and what makes me believe CenturyLink is a good investment long-term.
One big reason, maybe the reason, that anyone would buy a local telecom at this point has to be the company's dividend. With companies such as Windstream (NASDAQ:WIN) and Frontier (NYSE:FTR) both offering high dividend yields, investors have at least three choices in this field. When buying any of these three companies, investors need to understand that each company is facing essentially the same challenge. All of these companies provide local telephone access to both commercial and residential locations. With local telephone lines being canceled, in favor of Internet telephony, or wireless calls, this business is a dying breed. In order to battle this challenge, each provider is ramping up their high-speed Internet services, as well as commercial and enterprise offerings, and data center management. The company that ultimately wins at this game, will be the one that can increase its sales in these other areas fast enough to offset the decline in local access lines.
When it comes to dividends, there really is one ratio that matters most, and that is the free cash flow payout ratio. This is one of the primary reasons that CenturyLink is preferable over the other two. Each company's most recent financials provide us an opportunity to compare their free cash flow payout ratios, to see which one might pay the safest dividend. On this score, CenturyLink's payout ratio is 50%, Windstream's payout ratio is nearly 70%, and Frontier pays out about 65% of their free cash flow. While on the surface all three seem safe in the short-term, I'm much more comfortable with the company paying out half of its free cash flow versus 65% or 70%. A second consideration when you're looking at a high-yielding stock has to be the company's balance sheet.
If we compare these three companies' balance sheets directly, there is a huge difference between CenturyLink and the other two. The best description of this difference is, to look at each company's debt to equity ratio. CenturyLink has the lowest debt to equity ratio of these three companies by far. With a debt to equity ratio of 1.06 at CenturyLink, compared to 1.9 at Frontier, and 6.63 at Windstream, there's no question who has the strongest balance sheet. With the best balance sheet of the three, and the lowest free cash flow payout ratio, the only other question is what to expect from CenturyLink in the future.
On that note, the company is looking very positive. For the second quarter of 2012, the company expectations with $4.61 billion in revenue. On earnings-per-share the company beat earnings estimates for the fourth time in the last five quarters. The company's EPS coming in at $.65, looks good compared to analyst estimates of $.61 per share. For the full year, the most important guidance is in the area of free cash flow. CenturyLink maintained that free cash flow should be between $3.2 billion and $3.4 billion. With an annual dividend expense expected at $1.8 billion, even if the company hits the low end of this range, the payout ratio would still be only 56%. CenturyLinks' current dividend yield is less than either of their two competitors, but because of the lower free cash flow payout ratio I have more confidence in its sustainability.
Going forward, CenturyLink is poised to capitalize on growth in the cloud computing market. The company announced its Savvisdirect, as part of its industry-leading Savvis portfolio of cloud computing services. Savvisdirect is a service designed for all business users -- from the business owner to the developer, and from the large enterprise to the small business. Users can quickly get started with a credit card and gain instant access to the savvisdirect intuitive interface for simplified control of their cloud services. Developers will have access to a broad range of server options, scalable storage and diverse availability zones. IT administrators will have one place to procure, configure and deploy cloud services.
CenturyLink continues to see growth from its recent agreement with Verizon (NYSE:VZ) to be an authorized agent of Verizon Wireless and offer wireless and mobile services for its customers. This deal has helped the company maintain a presence in the mobile telecom world without spending a great deal in order to do so.
But CenturyLink has made it clear that its focus going forward is not in the consumer field. It is building up its business broadband capabilities as well as working towards being a major player in the cloud computing market. Its decision to forego a chance at buying Sprint (NYSE:S) made that clear. Sprint has meanwhile been bought out by a Japanese firm looking to gain entry into the consumer wireless market.
Longer-term, analysts expect negative earnings growth at Windstream, whereas CenturyLink is expected to show significant earnings growth over the next five years. While Frontier is actually expected to grow faster, the higher debt level, multiple earnings misses, and higher free cash flow payout ratio, make me nervous about that stock. CenturyLink is the better buy here, and is a solid choice for those investors who want to see growth coupled with good dividend yields.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.