Struggle Continues For Windstream

| About: Windstream Holdings, (WIN)

In the second quarter results this year, Windstream (WIN) clearly reflected growth prospects through its enterprise business and the broadband business. Together, these segments of Windstream are major revenue contributors, with enterprise contributing over 60% of revenue followed by the broadband segment contributing 8% of the company's total revenue. With around 3.4 million customers as of June this year, Windstream aims at growing its broadband business at high penetration levels.

Broadband - the new revenue penetration strategy

In order to grow the broadband business further, Windstream will implement a broadband stimulus fund, combining with Connect America Fund Phase-I, or CAF-I. It's a fund allotted to telecom companies by the Federal Communications Commission in order to develop communication infrastructure, like landline service and broadband in remote areas of the U.S.

Last year, Windstream was awarded 16 broadband stimulus projects in 13 states. For these projects, the company utilized $183 million from the Rural Utility Service broadband fund it received. It added $70 million from its own capital to complete these projects by the coming fiscal year. Once these projects are complete, Windstream will heavily penetrate these areas, aiming for over 50% subscriptions from area homes.

Along with this, Windstream is pursuing an additional $60.4 million from CAF-I. As on Sept 25, Windstream agreed to utilize $63.5 million, bringing the total allocation amount to over $129.3 million. This sum will be used to target new rural markets and convert the existing copper cables to fiber cables. Also, Windstream will be converting areas that get speed up to 768 kbps to higher speed broadband, providing about 12 Mbps - 20 Mbps speed to these areas.

Overall, this will help Windstream compete with existing cable companies, which provide services in cheaper packages, considering broadband as a standalone product. On completion of the above projects, we expect the broadband business to post double-digit revenue contributing figures.

Debt raising concerns

Although Windstream has good fundamentals to support future growth, the balance sheet reflects a totally different story, being heavily debt-ridden. It has increased its long-term debt by over 64%, from $5.36 billion in 2008 to $8.8 billion as on quarter ending June this year. This rise was mainly to support its growth prospects, in terms of the huge projects it received in the past five years.

Henceforth, Windstream now has a debt to equity ratio of 9.55 times. This is extremely high when compared to its peer competitors and the industry. Companies like Frontier Communications (FTR), and CenturyLink (CTL) have a debt to equity ratio of 2.08 times and 1.12 times respectively. Additionally, the industry average debt to equity ratio is even lower than these companies, posting at 0.92 times. Many times a company earns more profits, due to such outside financing, but Windstream has experienced no rise in profits. Instead, the net income declined by 65.7% from about $435 million in 2008, to $149 million as on the trailing 12-month basis. This shows that the rise in debt to equity ratio is negatively impacting Windstream's statements.

We are bullish on both FTR as well as CTL. Please read them here.

Interest expense taking its toll

One of the reasons for the decline in net income is the high interest expense the company pays every year. In the second quarter of this year, Windstream posted interest expense of $162 million, which is nearly 71% of the operating income. When comparing this phenomenon with its peer companies, it is found that CenturyLink pays around 45% of the operating income as interest expense, and Frontier Communication pays about 62%. This raises concern regarding the company's debt management, as even the free cash flows of Windstream have taken a toll. These have decreased by 23.7% from $763 million generated in 2008 to $582 million on the trailing 12-month basis.

This makes Windstream's future prospects regarding its high dividend yield questionable. Presently, Windstream has a high dividend yield of 11.80%, followed by Frontier and CenturyLink at 9.10%, and 6.10% respectively. Windstream has managed to pay dividends of $0.25 per share, bringing the yearly dividend to $1 per share since the last quarter of 2006. Going forward, based on the declining free cash flows and high level of debt, we don't consider the present dividend yield of Windstream sustainable in the long term.

On the other side, Frontier and CenturyLink have displayed good free cash flow growth. Frontier has raised its free cash flow generation from $451 million in 2008 to $750 million on the trailing 12-month basis. CenturyLink has displayed the best performance, in terms of free cash flow generation. Its free cash flows have increased by a massive 447% in the same period, generating about $3.1 billion presently on the trailing 12-month basis. Just like Windstream, Frontier has been impacted by high interest expenses. Also, the business has sustained around $1.2 billion revenue levels in the past five quarters, not forming any other source to increase the free cash flows.

Both of these companies have grown their business immensely in the past five years. Despite all the positive aspects displayed by Frontier and CenturyLink, neither has shown any spectacular performance in terms of stock price. In the past five years, Frontier's stock price has declined by 42%, and CenturyLink posted growth of 11.59%, just a notch above Windstream's stock price, which was up by 11.49%. Based on the high dividend yield these companies posted, income investors tend to monitor these stocks for their portfolios.

Mixed bag with future uncertainties

WIN Chart
(Click to enlarge)

WIN data by YCharts

Year-to-date, the stock price of Windstream has shown a decline of 2.2%. Moving further, we do not see any near term fundamental that will provide any boost to the stock price, at least before the end of this year. In addition, the company's present debt burden is bringing its dividend yield into the conversation.

Since the U.S. telecom industry is highly prone to dividends, as discussed in our previous article on CenturyLink, any change in the dividend distribution will have a similar effect on the stock price. The falling free cash flows of Windstream can lead to a dividend cut, which can have a negative impact on its stock price. This makes us bearish about the stock. Still, based on its long term growth opportunity through its broadband business, we find enough support for upside potential in the stock price of Windstream in the long run. Hence, we recommend a hold on the stock for now.

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. Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research 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.

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