For many years small telecom companies operating mainly fixed-line phone businesses offered extremely high dividend yields, sometimes greater than 10%. But as the country increasingly goes wireless the stable cash flows previously generated by fixed-line customers have begun to deteriorate.
CenturyLink, Inc. (NYSE:CTL) recently announced a quarterly dividend cut from $0.725 per share to $0.54 per share, a 25% decrease. This caused shares to plummet from about $41 to $34, with a new dividend yield of about 6.3%. This development brings into question the dividends of other telecoms which rely on legacy fixed-line revenues, namely Frontier Communications Corp (NASDAQ:FTR), which currently has a 9.78% dividend yield, and Windstream Corporation (NASDAQ:WIN), sporting an even higher 11.79% dividend yield.
The curious thing about CenturyLink, Inc. (NYSE:CTL)’s dividend cut is that the company simultaneously authorized a $2 billion share buyback program for the next two years. Looking at the company’s financials it seems that the dividend cut wasn’t really out of necessity. The company has guided for free cash flow between $3.0 billion and $3.2 billion in 2013, which is $4.82 per share based on the most recent share count. The dividend before the cut would have been only $2.90 per share, or $1.8 billion total, only 60% of the low-end free cash flow estimate.
The dividend cut is a result of a shift in strategy, with a focus on investing in growth areas instead of simply milking declining legacy businesses. The company spent $1.25 billion in acquisitions in 2011 and has stepped up its capital expenditures dramatically in the last couple of years. The dividend cut should be viewed as a positive instead of a negative, as the company believes that it can re-invest profits in the company at a sufficient rate of return. And even after the dividend cut the yield is still over 6%.
Is Frontier’s dividend in danger?
Frontier cut its dividend in 2010 and then again in 2012, now only $0.10 quarterly from a high of $0.25 quarterly. These cuts were necessary given that in 2010 the total dividend payout was about 88% of free cash flow, leaving very little capital to invest back into the company. Frontier has more than tripled the share count since 2009, so even the reduced $0.40 annual dividend per share represents 53% of the free cash flow even though the dividend has been reduced by 60%.
I don’t think we’ll see another dividend cut from Frontier within the next few years, given that the payout ratio has been brought to reasonable levels. But revenue declined in 2012, as did operating cash flow, and if these trends continue a dividend cut could be the in company’s future, albeit not for at least a few years.
What about Windstream?
It’s not a question of if but a question of when for Windstream’s dividend. The CEO stated in the most recent earnings release that:
“Our management team and the board of directors unanimously support continuing the dividend at its current rate because we believe it is the best way to create value for our shareholders”
If giving away most of the company’s profits is the best way to create value then the outlook for the company itself must be pretty grim. In 2012 Windstream’s free cash flow was $676 million. With a share count of 585 million 86.5% of FCF was paid out in dividends. The share count has increased by 25% over the last two years and capital expenditures have more than doubled in the same time period. The company paid $625 million in interest in 2012, up nearly 19% since 2010. All of the signs point to trouble ahead.
A dividend yield of over 11% is extremely tempting, but a cut within the next few years is highly likely. Buying stocks for the yield can be dangerous, and Windstream is a prime example of that danger.
Date from Morningstar
The article Are These Lush Dividends In Danger? originally appeared on Fool.com and is written by Timothy Green.
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