Send me real-time posts from this site at my email
Motley Fool

How Safe Is CenturyLink's Attractive Dividend?

CenturyLink's (NYSE: CTL) dividend yield, one of the highest in the telecom industry, is attractive to dividend-oriented investors. And its safe payout, at a fraction of the company's healthy free cash flow, makes it even more compelling. But as CenturyLink struggles to offset its declining legacy businesses with growth initiatives, let's take a closer look to see whether that generous dividend is safe.

Image source: Getty Images.

Revenue's shrinking – but that's not the whole story

CenturyLink's dividend represents a cash outflow of $1.1 billion. Given management forecasted a free cash flow in the range of $3.1 billion to $3.3 billion, the dividend seems safe. But revenue is declining, and this trend could impact free cash flow and threaten the dividend.

Because of the increasing use of high-speed Internet connections, CenturyLink's revenues from its legacy businesses -- low-speed broadband, traditional wireline phone services, etc. -- are shrinking rapidly. For example, during the last quarter, revenue from voice services dropped by 13% year over year.

But there's another reason for the drop in revenue. Management has been de-emphasizing less-profitable businesses, like Prism TV, to focus on profitability instead of revenue growth.

The company doesn't disclose the margins of its divested activities. But the evolution of adjusted EBITDA shows that the shift to more profitable businesses is taking place. During the last two quarters, adjusted EBITDA grew by $80 million while revenue declined by more than $600 million. The EBITDA growth isn't spectacular. But the contrast with revenue decline, thanks to better margins, is significant. During the last quarter, the adjusted EBITDA margin reached 40.7% compared to 38.5% one year ago.

While the evolution of communications technology hurts CenturyLink's legacy activities, it also favors its fiber-based businesses. Besides the forecasted threefold increase in global Internet traffic over the next five years, 5G also represents an opportunity. At first sight, 5G is all about wireless. But all 5G sites must connect to a core network via fiber links, and I expect CenturyLink to benefit from this development. The company partners with 5G providers to offer its network capacity, and it's currently expand its 3.5 million miles fiber-optic infrastructure to a total of 4.7 million miles. Thus, the disappointing top-line performance hides a more complex story.

How much of a threat is debt?

Even if revenue stabilizes and profits increase, investors must pay close attention to CenturyLink's significant debt load. Management expects net debt to decrease from 4.2 times the adjusted EBITDA one year ago to 3.8 times the midpoint of the forecasted 2019 adjusted EBITDA of $9.1 billion. But CenturyLink's debt ratio is still much higher than its competitors. Verizon Communications (NYSE: VZ) and AT&T (NYSE: T) announced that their net debt-to-adjusted EBITDA ratios would drop to 2x and 2.5x, respectively, by the end of the year.

The company isn't facing a debt wall over the medium term, though. About 65% of its debt is due between 2024 and 2057. And in the current low rate environment, the cost of debt is decreasing. Last week, the company announced the sale of $1 billion in senior notes due in 2027 at an interest rate of 4.625% to potentially replace existing debt carrying interest rates of 5.75% and 6.15%.

While the high debt doesn't represent a threat over the medium term, the company is exposed to a potential increase in interest rates. CenturyLink's interest payments on its debt should reach $2.1 billion in 2019. And cash flow, which I calculate as adjusted EBITDA minus the expected capital expenditure of $3.65 billion, would represent only 2.6 times the interest expense. Besides, the ongoing transition away from legacy businesses amplifies the company's risks.

Management plans to decrease the net debt-to-adjusted EBITDA ratio from 3.8x to a range of 2.75x-3.25x within the next three years. Considering that CenturyLink's forecasting a midpoint of $3.25 billion in free cash flow (after it pays the interest on its debt), this goal looks achievable. But given the risks associated with its legacy activities, management should place more emphasis on reducing net debt faster than maintaining its $1.1 billion dividend.

A safe payout ... for now

CenturyLink's forecasted free cash flow more than covers the dividend. And as the fiber-based businesses grow, management plans to increase free cash flow per share over the long term. Considering the modest growth of adjusted EBITDA, I expect the dividend to still represent a fraction of free cash flow over the next several years.

Still, CenturyLink remains in a risky situation. The company is still transitioning away from its legacy activities, while net debt will stay significant for many years. Its dividend may be safe in the medium term, but investors should make sure that revenues and profits from growing activities offset the declining legacy businesses over the next quarters. And investors should also look for a decrease in the company's net debt before they consider investing in CenturyLink for its dividend.

10 stocks we like better than CenturyLink
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and CenturyLink wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of June 1, 2019

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.


Source

Popular posts

Welcome!!! Is it your First time here?

What are you looking for? Select your points of interest to improve your first-time experience:

Apply & Continue