Investors are questioning whether CenturyLink's (NYSE:CTL) dividend is safe. The biggest reason for this seems to be that high dividends are an unlikely phenomenon and thus the increased yield must come with additional risks. I believe that CenturyLink's dividends are more than safe.
Often, when companies are paying high dividends, it is really more a function of a decrease in share price. For example, a company paying $2.16 in dividends per share, while the share price is trading at $108, is offering investors a 2% return. When that same share price is reduced to $24.90, the dividend equals 8.67% of the share price. While CenturyLink hasn't traded at $108 per share, the rest is true: CTL is offering investors $2.16 in dividend while the share price is trading at $24.90.
Since usually high dividends are merely a result of a depreciation of the equity, this will scare investors into thinking that the dividend is unsafe and might be reduced. The reasoning here is that, since the equity is depreciating, it must not be going too well with the company, and since things might not be going too well with the company, it might be forced to cut its dividends. More often than not, there is some truth to this, but sometimes this is just inaccurate.
Luckily, we can simply grab the company's financial statement to figure out which is the case. In the case of CTL, I feel comfortable stating with a high degree of confidence that the dividend is in absolutely no danger of being cut.
In this article I'll run the calculations to conclude that the dividend is safe even after a 100% stock dilution as a result of the Level 3 Communications acquisition. Whether management will actually be this generous is a question I have no way of answering. In the name of their responsibility towards shareholders, this would only seem logical. I must confess that, when it comes to Wall Street and exchange traded companies, logic is not a thing I assume or take for granted.
Like most that are reading this article, I like dividends and I love high dividends, which is why I noticed CTL. Naturally, I try to learn as much about a company before investing a dime in it. I have also learned that it is perhaps equally important to know what other investors are thinking. Seeking Alpha is great platform to find out what others are thinking. Not only through the contributors but also through the commentators. While reading some articles and comments, I came across this comment:
I didn't include the name of the commentator because it is irrelevant and because the user might not like to be quoted. The comment received three 'likes' which would indicate that multiple people agree with his somewhat blunt assessment. So let's answer his question:
"For how long do you really think CTL would pay a dividend yield that approaches 9.5%...????"
Short answer: not for long. I think that the share price will appreciate which in turn will reduce the yield. Remember that the relative yield is a function of the share price. Now, if we're talking about the dollar figure of $2.16, I can be brief on that as well: very long. Unless they actually increase the dividend. Most likely, the user is implying that the dollar figure yield will be decreased i.e. CTL will pay less than $2.16 in dividends per share. I strongly disagree. Let's run the numbers on this.
1) Operating cash flow $4.6 billion
2) Capital expenditure $3 billion
3) Net debt repaid $0.3 billion
4) dividend paid $1.2 billion
5) free cash flow $1.6 billion
5) net change in cash +96 million
So CTL has enough room to pay off $300 million debt while maintaining its capital expenditure and its dividend payment. The cash flow statement clearly indicates that CTL has ample room to pay its dividends. In fact, they can still pay off $300 million in debt and add $96 million cash on the balance sheet, while paying those dividends.
Outlook: Level 3 Communications
Some investors might argue that the operating cash flow has been decreasing every year since 2012 while capex has remained more or less the same. If CenturyLink's operating cash flow decreases further, the dividend will in fact be at risk. There's nothing wrong with this argument from a historical point of view. The company had $6.1 billion in operating cash flow in 2012. Fast forward to 2016 and the operating cash flow stands at $4.6 billion. Luckily, companies are not static entities so they can adapt. CenturyLink has adapted by acquiring Level 3 communications and with it, its $1 billion in annual free cash flows. If the deal were to go through, this would put CenturyLink's operating cash flow at $6.9 billion and its free cash flow at $2.6 billion. In other words, the merged company would have $1.4 billion in cash left over after paying $1.2 billion in dividends. Keep in mind that I am assuming that CTL continues to pay off $300 million in debt per year. The company might very well choose to refinance its debt instead of paying it off.
However, there's a caveat here. CenturyLink financed part of the deal with equity: LVLT shareholders will receive 1.4286 shares of CenturyLink stock for each Level 3 share. In other words, the amount of shareholders will almost double. To sustain their current dividend payment would thus require $2.4 billion instead of $1.2 billion. This is no problem for CenturyLink since it will still add $200 million to the balance sheet every year.
All in all, a high-yield dividend stock does not necessarily equate to an unsafe dividend and a risky stock. The current 8.67% yield offers a significant return for investors that are getting in right now. There is no reason to assume that this yield will be jeopardized in the short- to medium-term future.
Disclosure: I am/we are long CTL.
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.