These 3 Numbers Say To Stay Away: CenturyLink, Inc. (CTL), AT&T Inc. (T)

The Company Is 2^nd Worst According To This Metric
If Frontier had a pristine balance sheet, maybe I wouldn’t worry as much about free cash flow. If the company can more than cover its dividend, then who cares right? Unfortunately, Frontier does not have a debt free balance sheet, and according to one measure, the company is facing real challenges going forward.

One way to gauge the debt level at a company is, to compare their interest expense to their operating income. I find this measure useful because to be blunt, if a company can’t cover their interest payments with operating income, investors need to stay away. Windstream appears to be in the most precarious position, with 93% of their operating income covering interest payments. Coming in a close second is Frontier at 75.89%. When the company only has $0.24 out of each dollar of income after paying interest, you know there isn’t going to be much left for capital expenditures and dividends. By comparison, CenturyLink’s percentage is 44.29%, and AT&T comes in at just 13.65%.

To Buy Or Not To Buy?
Among the companies we’ve looked at, we can sort them into two categories. The first category contains Frontier with a yield of 9.78%, and Windstream with a yield of 11.79%. Both companies have a high level of interest expense to their operating income. These two companies also have relatively high debt levels, with debt-to-equity ratios of 2.03 at Frontier and 7.35 at Windstream. The bottom line is, their dividends are just waiting to be cut.

The second category includes AT&T Inc. (NYSE:T) and CenturyLink, Inc. (NYSE:CTL). While it’s true CenturyLink, Inc. (NYSE:CTL) just cut its dividend, the company simultaneously instituted a $2 billion share buyback. While CenturyLink’s yield of 6.24%, and AT&T’s yield of 5%, may not look as good as the others, at least their dividends are safe. AT&T’s free cash flow payout ratio was 78% in the last quarter. In addition, with a debt-to-equity ratio of just 0.60, the company’s balance sheet is much stronger than the competition. CenturyLink’s adjusted free cash flow payout is 67%. The company’s balance sheet was already stronger than Frontier or Windstream with a debt-to-equity ratio of 0.97.

The bottom line is, you can’t just look at yield and buy the shares. Investors enticed by Frontier’s 9.78% yield may get paid for now, but the company’s declining cash flow, high interest cost, and negative data growth are major concerns that can’t be ignored.

The article These 3 Numbers Say To Stay Away originally appeared on Fool.com and is written by Chad Henage.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.