The telecommunication sector has some of the best dividend paying companies - some of these companies have been paying exceptionally high dividends. However, the transition in the telecom sector has created some major hurdles for some of the players. Declining revenue is the common trend for almost all the players; as a result, two major players: Frontier Communications (NYSE:FTR) and CenturyLink (NYSE:CTL) have cut dividends.
The dividend yield offered by these companies was one of the primary reasons investors chose these stocks, and when the dividend cuts came, the stock prices came down substantially. In my opinion, dividend cuts were harsh but necessary, and now these companies are in much better position to maintain their current dividends and spend ample funds on expansion. The third company that I have talked about in this article is still paying very attractive dividend. However, Windstream (NASDAQ:WIN) is facing the same problems faced by its peers.
Frontier mainly operates in rural areas and small and medium sized enterprises. The company is an integral player in telecommunication industry competing with industry giants like Verizon (NYSE:VZ) and AT&T (NYSE:T) for market share. The biggest problem for Frontier rises from the main segment of its market: rural customers. We are seeing a shift in rural areas from traditional landlines to cell and wireless. As a result, the company is losing subscribers and revenues.
In 2012, the total customer metrics declined by 7% whilst operating revenues fell by 4%. The decline in customer base was partly cushioned by a revised pricing strategy. Net income amounted to 153 million, a decline of 2.7% year-over-year. The increase in competition from wireless and cable service providers helps explain the decline in earnings. The economic conditions did little to reduce the losses.
Frontier pays a quarterly dividend of $0.10, yielding 9.7%. Free cash flows have been improving gradually for Frontier - the company reported $750 million in free cash flows in 2012, and for the trailing 12 months, the free cash flows stand at $762 million. However, it should be kept in mind that free cash flows have shown an improvement due to a decrease in capital expenditures, and cash flows from operations have actually declined.
As I mentioned above, the biggest problem for Frontier is declining revenue from the core operations of the company. A look at the financial statements also tells us that the cash flows from core operations have been falling, and the company has been trying to control its capital expenditures in order to improve the overall cash position. Nonetheless, the payout ratio of the company based on free cash flows is around 50%, which should allow it to weather this decline in revenue and maintain current dividends. Frontier is making considerable progress in its broadband segment, which should encourage its existing shareholders.
Windstream offers both fixed line and wireless services. The company has been seeking growth via acquisitions and data services as it shifts its target market from home customers to small businesses. As the Telecom industry sees a transition towards the provision of wireless services, Windstream follows a similar trend.
Windstream reported its first-quarter results, which came out to be close to analyst estimates. However, there was a decline compared with the same period last year. The trend is almost the same as with other peers. However, the fiber network of the company is giving encouraging results. On the other hand, voice and long distance calls are losing revenue. Adjusted OIBDA of the company has also declined marginally from $587.4 million in 2012, to $587.1 million in the last quarter.
Windstream management has been able to keep its promise of paying the dividend when its peers have been cutting dividends. The stock pays an annual dividend of $1, yielding 12.19%. The Free cash flows of the company for 2012 amounted to $676 million, an increase of up to 28% as the management takes austerity measures to maintain its dividend legacy. The payout ratio of the company based on free cash flows stands at 87% -- a payout ratio that high does not leave much room for improvement and it can cause problems if there is a small fall in cash flows.
Windstream is also losing subscribers like other telecom players - the company's access lines including high-speed internet declined by 4% year-over-year. In addition, voice lines and digital television subscribers declined by 5% and 4%, respectively.
CenturyLink serves a diverse range of customers ranging from residential to government organizations. The company like Windstream and Frontier has shifted its sales portfolio towards small and medium enterprises through acquisitions and provision of broadband services.
CenturyLink recently cut its dividends, which caused a heavy sell-off. At the moment, the company pays an annual dividend of $2.16, yielding 5.8%. The free cash flows of the company stand at $3.1 billion and the payout ratio is at 58%. CenturyLink's current payout ratio is easily manageable and gives the company some room to spend more on expansion.
At the moment, the main growth drivers for the company are broadband data services. Regional and wholesale markets are declining while the enterprise market, both network and data hosting are growing for the company. CenturyLink has added a substantial number of new subscribers to its broadband subscriber base.
CenturyLink has massive amounts of debt ($19.4 billion at the end of the year), and the company is trying to reduce these debt levels. In the near future, I do not believe the debt of the company will pose any trouble. Furthermore, CenturyLink will be able to maintain its current dividend levels and I do not see another cut in the short term. The dividend cut has priced the stock attractively and there is substantial upside potential in this stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.