Solid Dividend or Blowing in the Wind?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Admittedly I get behind on my reading sometimes. I tend to mark articles from The Motley Fool that I want to read, and then go back to actually read them later. This is what happened when I ran across an article about Windstream (NASDAQ: WIN) in my reading list. To be blunt I've never been a fan of what I still refer to as the local telecoms. Companies like Windstream and Frontier Communications (NASDAQ: FTR) are in a race against time. Companies like these are trying really hard to sign up new business customers, and new consumer broadband customers, to offset their losses in landline subscribers. The trend is clear, landline phones as we know them are becoming a thing of the past. The landline business is very profitable, but is slowly being whittled away. This was part of the issue that hurt Windstream stock after they reported earnings, and what led me to investigate the company further.
The article in question was by fellow Fool Brian Pacampara. He gave a short synopsis of why Windstream shares were down nearly 16% to a fresh two-year low at the time. Brian's bottom line was, he believed this drop represented a good long-term buying opportunity. He noted that Windstream's CEO Jeff Gardner said in the earnings release, “I am extremely confident in the business that we have built. Through targeted acquisitions and our strategic growth initiatives, we have assembled an attractive set of assets capable of generating consistent cash flows to support our dividend over a long period of time and to provide other opportunities in the future to increase shareholder value.” At this point if the reason to buy Windstream is their dividend, everything the company does revolves around the ability to continue this payout. Let's break down what's happened with the company in the last few months, and see if this dividend is sustainable, as the CEO suggests.
Looking at the company's last earnings report, we see that total revenues were down 0.50% and adjusted operating income was down 1.6%. Admittedly, I don't like when companies start using a bunch of adjusted numbers. However, Windstream's acquisition of PAETEC was a $2.4 billion deal so some adjustments are necessary. The part I didn't like about Windstream's adjustment to operating income was the company excluded pension expense. I'm willing to live with restructuring charges and integration charges. I can even get past excluding stock-based compensation, but pension expenses are real dollar expenses. Unless the company is planning on stopping its pension, I don't understand the logic in this exclusion. That being said, even without a bunch of adjustments to income, cash flow is what investors need to really focus on.
Windstream reported non-adjusted figures of $438.8 million in operating cash flow, $226.1 million in capital expenditures, and the company paid $146.5 million in dividends. This works out to a free cash flow payout ratio of 68.88%. On paper, this ratio would seem to indicate that the company's dividend is safe at least in the short term. That comment can't be understated as the stock currently yields 10.54%. There are just a few problems longer-term.
First, the average analyst expects negative EPS growth over the next few years of about -3.5%. Second, Windstream hasn't shown the ability to meet existing estimates. In three of the last four quarters, the company has missed estimates. Most importantly, the company's balance sheet is very weak. As of the last quarterly report, the company has $89.8 million in cash and owes $8.788 billion in long-term debt. Even with free cash flow payout ratio of 68.88%, that doesn't give the company a lot of money to pay down debt. If last quarter is any guide, the free cash after dividends amounted to about $66 million. Even if the company was able to replicate this result into the future, it would take 66 quarters (aka, over 16 years) to just cut long-term debt in half. That is a scary statistic, and something investors need to think about before considering buying Windstream.
To put things into perspective, Frontier Communications is a company I called out before, and questioned if the dividend was safe. In that post, one of my worries was the company's debt-to-equity ratio. Frontier's debt-to-equity ratio had risen from 1.58 to 1.84 over the last year. Windstream by comparison looks even worse. While the company's debt-to-equity ratio has improved in the last four quarters, from over 9.0 to just over 6.0, this still means Windstream's balance sheet is much worse off than Frontier. In sheer numbers, Frontier has less long-term debt by about $1.1 billion, the company has more cash by $250 million, and has more than twice the equity. In every way, Frontier's balance sheet is better. The dividend is very high and is covered for now, but the balance sheet is terrible. What should investors do?
To be blunt, I like the dividend a lot, but I wouldn't touch Windstream right now. Some of their numbers are promising, like the fact that 68% of their revenues were from business and consumer broadband. That is a positive because these are still growing divisions with revenues up 3.2% and 5.9%, respectively. That being said, when I see that un-adjusted revenues are up 51%, but total costs are up 77% I am afraid for the company's future. I know the company may figure out a way to wring cost savings out of their expenses. The problem is, the number that keeps flashing red in my mind is $8.78 billion in long-term debt. This is a case where if you had to choose between Windstream and Frontier, I would rather own Frontier. Both companies have challenges, but Frontier's superior balance sheet gives the company more staying power. Since both companies pay similar dividends, there just doesn't appear to be a reason to take a risk on Windstream right now.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. If you have questions about this post or the Fool’s blog network, click here for information.