Why I Bought CenturyLink
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After about two years of considering which local telecommunications provider to invest in, I finally made the decision to purchase shares in CenturyLink (NYSE: CTL). I will say, for a while I considered all local telcom operators to be untouchable, because one of their primary businesses is going the way of the dinosaur. With residential phone lines being canceled left and right, I worried about how these companies would survive. However, when I see a yield of 7% or more in any company, I immediately get interested enough to do my due diligence. What I found is, of the three major local telcom providers, only CenturyLink would allow me to sleep at night. Let me explain what I found, and what makes me believe CenturyLink is a good investment long-term.
The main reason that anyone would buy a local telco. at this point, has to be the companies dividend. With companies such as Windstream (NASDAQ: WIN) and Frontier Communications (NASDAQ: FTR), both offering high dividend yields, investors have at least three choices in this field. When buying any of these three companies, investors need to understand that each company is facing essentially the same challenge. All of these companies provide local telephone access to both commercial and residential locations. With local telephone lines being canceled, in favor of Internet telephony, or wireless calls, this business is a dying breed. In order to battle this challenge, each provider is ramping up their high-speed Internet services, as well as commercial and enterprise offerings, and data center management. The company that ultimately wins at this game, will be the one that can increase its sales in these other areas fast enough to offset the decline in local access lines.
When it comes to dividends, there really is one ratio that matters most, and that is the free cash flow payout ratio. This is one of the primary reasons that I chose CenturyLink over the other two. Each company's most recent financials provide us an opportunity to compare their free cash flow payout ratios, to see which one might pay the safest dividend. On this score, CenturyLink's payout ratio is 50%, Windstream's payout ratio is nearly 70%, and Frontier pays out about 65% of their free cash flow. While on the surface all three seem safe in the short-term, I'm much more comfortable with the company paying out half of its free cash flow versus 65% or 70%. A second consideration when you're looking at a high-yielding stock, has to be the company's balance sheet.
If we compare these three companies balance sheets directly, there is a huge difference between CenturyLink and the other two. The best description of this difference is, to look at each company's debt to equity ratio. CenturyLink has the lowest debt to equity ratio of these three companies by far. With a debt to equity ratio of 1.03 at CenturyLink, compared to 1.74 at Frontier, and 6.16 at Windstream, there's no question who has the strongest balance sheet. With the best balance sheet of the three, and the lowest free cash flow payout ratio, the only other question is what to expect from CenturyLink in the future.
On that note, the company has given some pretty specific guidance for the second quarter and the remainder of 2012. For the second quarter of 2012, the company is expecting revenue of between $4.55 billion and $4.60 billion, this is right in line with what analysts are calling for with an average estimate of $4.57 billion. Where earnings-per-share is concerned, the company may beat earnings estimates for the fourth time in the last five quarters. The company's guidance of EPS coming in at $.59 to $.64, looks good compared to analyst estimates of $.61 per share. For the full year, the most important guidance is in the area of free cash flow. CenturyLink maintained that free cash flow should be between $3.2 billion and $3.4 billion. With an annual dividend expense expected at $1.8 billion, even if the company hits the low end of this range, the payout ratio would still be only 56%. CenturyLinks' current dividend yield is less than either of their two competitors, but because of the lower free cash flow payout ratio I have more confidence in its sustainability. This brings us to the last test that I used, which was comparing expected earnings growth at each company.
Longer-term, analysts expect negative earnings growth at Windstream, whereas CenturyLink is actually expected to show significant earnings growth over the next five years. While Frontier is actually expected to grow faster, the higher debt level, multiple earnings misses, and higher free cash flow payout ratio, make me nervous about that stock. You can see you based on the combination of these factors why CenturyLink made so much sense to me.
MHenage owns shares of CenturyLink. 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.
