A 7% Yield You Can Believe In

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

I honestly believe that sometimes in the stock market investors sometimes are blinded to the positive attributes of certain companies because of the industry they operate in. A company like CenturyLink (NYSE: CTL) is a great example, as the stigma of operating in the local telecommunications field keeps some investors away. However, it pays to do your research, and investors looking for a high-yield that they can believe in should look no further.

There is no question that many competitors are trying to take CenturyLink's customers. Whether it's a landline customer that decides to only use their wireless phone, or a customer that switches from CenturyLink to a larger player like Verizon (NYSE: VZ), competition exists on all sides. However, the company is doing its best to offset land line losses with broadband and video growth. CenturyLink is also doing a good job increasing its cash flow, and improving its balance sheet at the same time. In fact, one of the biggest misconceptions about local telecom players is, the idea that continued land line cancellations ultimately doom the company for failure. While it is true that land line cancellations don't help, many of these companies have diversified into web hosting, high-speed internet, and enterprise offerings. While these newer services should help investors perception of the local telecom players, they are still looked at as boring dividend paying stocks. That being said, there will be long-term winners and losers in this industry and knowing which companies are likely to come out on top is key.

While this might sound like a brash statement, CenturyLink is the best value in the local telecom business. I know that the stock pays the lowest yield at 7.5% compared to 8.4% at Frontier Communications (NASDAQ: FTR), and 11.8% at Windstream (NASDAQ: WIN). However, all yields are not created equal, and understanding the difference between these three players is critical. Let's look at how CenturyLink performed in the most recent quarter and I'll show you a few reasons it appears CenturyLink is poised to continue delivering on its high yield for investors. 

In the last three months, CenturyLink showed revenue down 1.3%, but EPS increased by 8.2%. In addition, the company saw positive growth in its high-speed Internet business with 44,000 new customers. While it's a newer venture, Prism TV saw a 11% quarter-to-quarter increase in subscribers, and ended the quarter with 104,000 customers. In a strong signal that the company's losses in access lines is improving, CenturyLink saw its access line losses improve from a 7.1% annual rate to 5.8%. What really seems to set CenturyLink apart from its local telecom competitors is its balance sheet and cash flow.

In the most recent quarter, CenturyLink generated enough free cash flow to cover its dividend with a 50.98% payout ratio. By comparison, it took a huge dividend cut to bring Frontier's free cash flow payout ratio to 50.78%. Windstream's dividend appears to represent the biggest risk with a nearly 150% ratio. On the opposite end of the spectrum, Verizon appears to have the safest dividend with a payout ratio of just 23.21% in the recent quarter. However, Verizon's yield is significantly lower than the rest at about 4.6%. As you can see, CenturyLink and Frontier offer high yields with reasonable payout ratios, but one thing that favors CenturyLink is their balance sheet versus their competition.

Since the telecommunications industry requires a high level of capital expenditures, it's important that investors keep an eye on the level of debt a company carries. Higher debt levels can push management to choose between investing for the future versus making cuts to handle interest payments. This is one prime reason I believe CenturyLink offers investors the best opportunity in the local telecom field. The company's debt-to-equity ratio is 0.97 as of the most recent quarter. By comparison, Frontier's debt-to-equity ratio is much higher at 1.93, and Windstream is an astronomical 6.31. Even looking at Verizon, they carry a debt-to-equity ratio of 1.23. In addition, CenturyLink's lower debt-to-equity ratio has been improving as the company retired about 8.6% of its long-term debt compared to last year. If there is one financial measure that CenturyLink can improve on it's their margins.

In similar manner to the other local telecoms, CenturyLink has been busy making acquisitions over the last few years. While these acquisitions improve the company's long-term prospects, in the short-term they hurt margins. The company will need to continue to focus on improving its efficiency, because on an operating margin basis, their competition is doing a better job. For instance, Frontier shows an operating margin of almost 22% last quarter, and Windstream even managed a margin of nearly 16%. When you realize that CenturyLink's margin is just 14.3%, you can see that price adjustments and cost cutting is clearly in order. In the short-term this looks like a negative, but longer-term it is actually a positive. CenturyLink can improve its operations and thus improve the company's earnings and cash flow. Since the company is already turning in good earnings and growth, any improvement would lead to greater gains for shareholders.

Speaking of growth, CenturyLink has yet another advantage over its competition and that is in the area of future earnings growth. Analysts expect the company to grow earnings by more than 8% in the next few years. Compared to less than 6% growth at Frontier and negative 1.9% growth at Windstream, this is a clear positive for investors. What's amazing is though the company is expected to grow faster than their competition; investors are not pricing the shares accordingly. In fact, CenturyLink currently has the lowest forward P/E of the local telecoms at about 14.5. The best combination of growth and income in the field is offered by Verizon at 16.16% from expected EPS growth and dividend yield. However, CenturyLink at a lower valuation offers a combined total expected return of 15.89%. With a relatively low P/E ratio, good growth, and the strongest balance sheet, this is a 7% yield you can count on.

MHenage owns shares of Verizon Communications and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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