3 Undervalued Telecom Stocks Offering Yields Above 5%

Includes: CTL, FTR, T
by: Efsinvestment

By Siraj Sarwar

Dividend investing is a long-lasting process where capital is invested today with the overall intention to receive dividends for several years to come. Dividends have historically demonstrated about 40% of average annual total returns, exhibiting why they are an essential part of the investing decision. For dividend investors the telecom industry might be a safe harbor to invest money for several years.

The telecom industry is one of the fastest-growing industries in the United States. The industry has displayed incredible growth and has been able to generate large margins over the years. Consequently, many companies in the industry are making enormous profits and paying substantial dividends to investors.

In this article, I pick three companies for substantial dividends. These are CenturyLink (NYSE:CTL), Frontier Communication (NYSE:FTR) and AT&T (NYSE:T). All the companies listed in this article offer a dividend yield over 5 percent; moreover, these companies have a long history of dividend payments. Over the years, these three companies have been showing an exceptional growth in revenues and operating margins. Furthermore, their dividends are growing at an enormous pace. These stocks are also trading below analysts' target prices. Let's examine each company's ability for the projected returns.

CenturyLink is one of the biggest telecommunication corporations in the United States. The company is a leader in the network and services market and has a long history of dividend payments. Furthermore, CenturyLink offers a massive annual dividend of 2.90 per share, yielding at 7.96%.

Recently, CenturyLink reshaped its business profile with the acquisitions of Embarq, Qwest, and Savvis. The company's revenue is now much more heavily weighted toward enterprise and wholesale services. This move provides greater revenue stability than the traditional residential business.

In spite of higher churn rates, the company was able to grow revenue at an enormous rate. In the previous five years, the company was able to grow revenues at an average of 44%. CenturyLink is anticipating a similar trend for the next few years. Additionally, the company is growing its revenues through acquisitions.

As another representation of their revenues, CenturyLink also has incredible margins on sales. In the ttm, the company's gross margin stands at 55%. This is quite an achievement of margin relative to the tough macro environment. CenturyLink also has an exceptional operating margin of 13%.

With the company's growth, CenturyLink has had exceptional cash flows operating at an exponential pace. At the end of 2011, the company generated $4.2 billion in operating cash flows. In the ttm, the company's operating cash flow stands at $5 billion. This represents a massive increase of $0.8 billion over the previous year.

I expect the firm will still struggle to grow in aggregate as it fights the decline of the phone business. In spite of this challenge, the firm should generate enough cash flow to support the dividend for the foreseeable future.

Frontier Communications is the second stock on the compilation. Currently, the company is paying a quarterly dividend of $0.10 per share. Last year, the company cut its dividends in an attempt to reduce debt levels. At the moment, Frontier is going though an integration process, seeking to expand its size by acquisitions. As a result, though, Frontier came under a massive debt.

Since 2010, the company has been suffering from high levels of debt and interest expenses. Furthermore, it has paid a large amount of integration costs in the past two years. Consequently, it reduced dividends for the long-term health of the company. In addition, the company is seeking to reduce operational expenses. By the end of 2013, Frontier seeks to reduce expenses by 25%.

However, the company has displayed an incredible cash flow growth over the years. In the ttm, the company generated $5.4 billion in operating cash flows. The company has a potential to expand its operating cash flows at an incredible pace, though, considering that it has increased by $1.2 billion compared with the previous year. Additionally, over the previous 12 months, the company paid $1.8 billion in dividends and produced $2.4 billion in free cash flows.

With the past dividend cuts and interest savings, Frontier's cash flow will further increase, and it will keep similar dividends over the next quarter due to its debt reduction strategy. In the future, I expect a hefty raise in the dividends.

AT&T is the third stock on the dividend collection. AT&T is one of the most significant communication service providers in the United States. The company offers a quarterly dividend of $0.45 per share and yields at 5.07%. Recently, the company raised its quarterly dividend by one cent. In addition, it has a long history of dividend payments.

The company has displayed an impressive revenue growth over the years. In the past five years, the company raised revenue by 1.5%. AT&T showed an impressive growth in cash flow, and at the end of 2012, its cash flow from operations stood at $39 billion.

AT&T is also investing heavily in growth opportunities. At the end of 2012, the company had invested $19 billion in growth opportunities. At the same time, the company's FCF increased by $4.5 billion compared to the earlier year, returning $23 billion to the shareholders in the form of dividends and buy backs.

The company's payout ratio stands at 60%, indicating another increase in dividends. I anticipate the corporation to raise its dividends due to the strong growth in free cash flows.

Final Thoughts

All the corporations pointed out in this article have solid financial numbers and appealing growth opportunities. I believe these three stocks will be strong additions to any dividend portfolios. Strong cash flows and increasing revenue will allow these three corporations to maintain hefty dividends.

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

Business relationship disclosure: Efsinvestments is a team of analysts. This article was written by Siraj Sarwar, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.