Investment in Windstream Appears to Be a No-Brainer

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Note: This article has been amended to better reflect Windstream's dividend scenario.

Windstream (NASDAQ: WIN) has paid an annual dividend of $1 per share every year starting in 2007. Most recently it announced a $0.25 quarterly dividend with its first quarter earnings report in May of this year. But there are reasons to be concerned with the company’s ability to continue to pay such a dividend going forward. Will the company be able to pay its generous dividend going forward?  I think it can and the following are my reasons.

Is debt going to shrink the dividend?

Windstream has taken on debt recently through acquisitions meant to grow the company’s business, consumer broadband, and data and integrated services sectors. The company’s interest expense has increased each year from 2009 through 2012, rising 25%. The company has also financed these acquisitions in part by issuing new shares, increasing the total number of outstanding shares by over 115 million the previous 3 years, increasing the total dividend payment.

Detractors point out the increasing debt burden along with the increase in dividend payouts as proof that Windstream’s dividend is currently unsustainable. But I think there are a few problems with this argument:

 First, Windstream announced the same $0.25 quarterly dividend in May. The company’s debt has not hampered its ability to pay a dividend at this point. Management is committed to the continuation of the dividend and is making it a priority.

Second, the company generated $70 million in free cash flow during the quarter, but its adjusted free cash flow was $248 million. For 2012 the company totaled $676 million in free cash flows and paid a dividend with a 76% ratio to adjusted free cash flows. The 76% ratio is what investors should expect as 2013 continues given that the company has been planning on sizeable reductions of capital investment expenditures in 2013. 

Business and consumer broadband lead the way

Windstream is shedding its rural telecom legacy and now generates 71% of its total revenue from business and consumer broadband. Growth in these areas have been fueled by acquisitions such as PAETEC and Hosted Solution. A new collaboration with Avaya Aura to expand its managed unified communications services will continue this growth trend. I expect to see modest growth for the remaining quarters of 2013.

Competitors taking a different path

CenturyLink (NYSE: CTL) is another rural telecom that is shedding its legacy business model by growing its business and eneterprise services. It announced a 26% dividend cut earlier in the year and has adopted of strategy of paying down debt. Even with the cut the company still pays a nice dividend. With its new strategy I expect to see a better balance sheet looking forward and a return to positive revenues.

Frontier Communications (NASDAQ: FTR) has been hampered by declining revenues and cut its dividend last year. I believe lack of investment has played a role in Frontier’s problems recently. If debt is used to strengthen or build out areas that are seeing growth then it makes sense, Frontier looks like it has been too risk-averse. I do not see Frontier making any movement one way or the other for the next few quarters.

Even a cut of dividend will not hurt too much

When Frontier cut their dividend the company’s saw their stock take a dip of roughly 15%. CenturyLink has bounced back a little but is still trading at almost $36 per share while it was trading at almost $42 before the cut. Frontier continues to trade at roughly 15% less than its price before the dividend cut.

One interesting aspect of CenturyLink’s dividend cut was its apparent effect on CenturyLink's stock price. The latter saw its stock dip roughly 15% as well as the former at the same time. This is strong evidence that a dividend cut is already priced into Windstream’s stock price. While the stock would probably take another dip, of around 5% or so, if a dividend cut is announced I think the risk is worth it to hold on or even to buy Windstream.

I do not think Windstream will be cutting the dividend anytime in the near future. Management is strongly against it and has said so on many occasions. The financials still work for the company to continue paying. The strategy of acquisitions and partnerships to be a strong player in growing sectors is providing the revenue to both pay down the debt and provide for the dividend. Finally, the risk of investing in this stock right now is low. A dividend cut appears to be already priced in to the stock, so a dividend cut, as unlikely as it is, will not send this stock into a deep 15%+ drop. All this means good times for the Windstream investor.

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William Alder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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