Valuation
CenturyLink’s shares trade at a forward P/E multiple of 11.7 and offer a dividend yield of 7.7%, which is above the stock’s five-year average yield of 7.2%. At first glance, CTL shares look cheap.
With annual earnings growth expected to be flat to slightly negative over the next decade, CenturyLink shareholders would be fortunate to receive an annual return equal to the current dividend yield (7-8%). That’s below the market’s long-term compound annual growth rate of about 9% despite the riskier nature of CenturyLink’s standalone operations.
However, doesn’t the high dividend yield potentially justify owning shares? After all, if your main concern is income, then perhaps a 7.7% yielding telecom might still make sense, especially since analysts think that the dividend might survive at its current level and the stock’s beta is relatively low (0.80).
If my concerns over the company’s debt prove true and management cuts the dividend again, say by 25% like they did the last time, then suddenly CenturyLink’s dividend yield would fall to about 5.7%.
Before you run out and buy this under the “dirty value” banner, remember the wise words of history’s greatest investor, Warren Buffett. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” (read Warren Buffett’s top 10 pieces of investment advice here).
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In this case, I consider CenturyLink a classic example of a fair company at best and given the headwinds it business and dividend are facing, I wouldn’t consider the current price of about $28 “a wonderful price.”
There are definitely worse stocks to hold for a rather speculative 8% yield as part of a diversified portfolio, but income investors can’t forget the importance of capital preservation and total return. An 8% dividend does one little good if the stock’s price permanently drops 30% as the business terminally shrinks.
In my view, only highly risk tolerant investors should give CenturyLink a look. Even then, the stock should be approached with great caution. It is an investment that I will avoid due to business quality, financial leverage, and long-term growth concerns. Management sure has a lot of work to do to turn the ship around, if they can.
Conclusion
Centurylink Inc (NYSE:CTL) represents a high yield that looks somewhat safe…for now. However, with its most important and highest margin business segments under pressure from much larger, better capitalized, and investment grade rated rivals, it’s likely that the company will struggle to merely hold the line in terms of top line sales and could suffer further margin erosion.
Combined with management’s penchant for big acquisitions and CenturyLink’s already highly leveraged balance sheet, the threat of rising interest rates, and the risk of 5G disrupting its bread and butter internet business down the road, I consider the current payout at risk of another 2013-like dividend cut over the next few years.
In other words, dividend growth investors are likely better off going with larger, more established rivals such as AT&T or Verizon than with this smaller, and frankly outgunned, regional telecom provider.
While the yields these safer stocks offer may not be quite as attractive, these companies’ payouts are far more secure, have better growth prospects, and are far more likely to deliver better long-term, risk-adjusted returns.
Disclosure: None
