Frontier Communications (NYSE:FTR) continues to plunge due to a collision of extraordinary events. The dividend yield has soared to 21% that typically signals a dividend cut is on the way.
The stock now trades under $2. My investment thesis recently suggested watching from the sidelines, but has the question now as whether the further collapse provides an opportunity.
Multiple events are colliding to cause extra panic in the market. First and foremost, Frontier Comm caught the market off guard with the decision to seek a reverse split at the May annual meeting. Typically, the market automatically dumps a stock on this news regardless of the situation. Second, the telecom was removed from the S&P 500 index on March 20. Third, analysts have started questioning the dividend as the yield soars. The combination of these three events causes panic whether legitimate or not.
The crazy part of the story is that Frontier just reported Q4 results and provided 2017 guidance. As my last article highlighted, the company has the free cash flow to support keeping the current dividend. The 2016 adjusted free cash flow was $921 million with dividends of only $475 million.
My research going back to the end of 2014 has long questioned why Frontier raised the dividend 5% instead of paying off debt and deleveraging. Regardless, the call by Goldman Sachs to downgrade the stock to a $1.50 price cut on suggestions that entire dividend could be cut appears irrational.
The call by analyst Brett Feldman only suggests a dividend cut as a move to build liquidity for future debt maturities, but doesn't suggest any material change in cash flows. In fact, the suggestion is that Frontier uses the future free cash flows to pay off debt, instead of a dividend. This shouldn't change the valuation of a company.
Frontier provided the following 2017 guidance at the end of February. Nothing has changed to these numbers, and Frontier expects free cash flow of at least $800 million with the possibility of reaching $1.0 billion.
What has changed is the psychology of the market surrounding the reverse split scheduled for a vote at the annual meeting in May. As well, the drop from the S&P 500 causes forced selling by index funds.
The combination of these events sent the stock down and the dividend up, which causes irrational fears surrounding a dividend cut. The company has no material debt maturities until 2020 providing plenty of time to rollover those amounts.
Of the $17.4 billion in debt, the company only has about $1.8 billion due by the end of 2019. Frontier had $522 million in cash and will have cash flow above dividend payments to cover most of the outstanding debt in that time period.
The key investor takeaway is that the company could cut the dividend 50% and add nearly $250 million to annual cash flows. The move isn't needed, but the market tends to act irrational and might force the hand of Frontier.
Either way, I'm still sitting on the sidelines waiting for more details on the reverse split and to see whether the company is forced into a dividend cut. Until more details emerge on these issues, the Goldman Sachs target of $1.50 could easily be hit.
Disclosure: I/we 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.
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