I Wish it Were Simple

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

Sometimes it's hard to know whether to hold a stock, buy more, or sell it. You have to look at the company's performance, remind yourself of why you bought the stock in the first place, and then see if anything has materially changed. This is sort of where I am with CenturyLink (NYSE: CTL). On the one hand, the company had to cut its dividend, but they also instituted a significant share repurchase at the same time. However, looking at their recent earnings makes me wonder if a better option is presenting itself.

The search for something better
I believe that periodically re-evaluating your positions is key to staying ahead of the game. Even great companies can decline, and sometimes companies that are down in the dumps can rebound.

One of the reasons I bought CenturyLink originally was the company's yield was north of 7%. However, when they cut the dividend, this drove my effective yield down to about 5.8%. That being said, their share repurchase plan seemed a reasonable substitution, and I held on. The good news is now their core free cash flow (net income + depreciation – capital expenditures) payout is just 45.43%, and their balance sheet is stronger than most of their peers with a debt-to-equity ratio of 1.04.

Looking at their peers, investors looking for yield might gravitate toward Windstream (NASDAQ: WIN) and their 11.4% yield. However, the company's core free cash flow suggests a payout ratio of 107%, which I'm not comfortable with. In addition, Windstream's balance sheet is downright scary with a debt-to-equity ratio of nearly 8.

Verizon (NYSE: VZ) is the poster child for stability in the sector, but the company's yield of 3.9% doesn't exactly scream opportunity. However, the company's core free cash flow payout is just 27.41%, and their debt-to-equity is far lower than their peers at just 0.48.

The company that has caught my attention is Frontier Communications (NASDAQ: FTR). While it's true that Frontier had to cut their dividend last year, the stock currently yields more than 9%. Normally a 9% yield would make me nervous. However, the company's core free cash flow payout is a reasonable 60.33%. While Frontier's debt-to-equity ratio is higher than either Verizon or CenturyLink at 2.06, the company's balance sheet is much stronger than Windstream.

Is CenturyLink losing ground?
Whether you believe CenturyLink is losing depends on what you look at. If you are looking for yield and growth, than Frontier has everyone beat. Analysts are calling for over 20% EPS growth in the next few years. Compared to Verizon's expected growth of about 9%, CenturyLink at 1%, and negative growth of more than 11% at Windstream, Frontier seems to be the clear leader.

Another area where CenturyLink and Frontier have switched places is in operating margin. At the beginning of last year, Frontier's operating margin was under 15%. Today, the company reports a margin of 20.81%. This huge increase is good enough for second behind only Verizon with a 21% margin. By comparison, CenturyLink's operating margin now stands at 17.33%, which is only ahead of Windstream at 15.76%.

In addition, there are three key measures for local telecom investors to keep an eye on. These companies need slow voice line declines, and fast growth in high-speed Internet and video subscribers. By these measures, CenturyLink isn't doing as well as some of their peers.

When it comes to voice line losses, Verizon is the only one of the four companies that doesn't have to worry as much, because of this little division called Verizon Wireless. The local telecoms are in a different situation, because they need to limit the losses from their cash cow. By this measure, CenturyLink reported line losses of 7.1% versus a 5% decline at Windstream, and a 5.03% decline at Frontier.

High-speed Internet performance at CenturyLink was equally middle of the road. Verizon reported high-speed Internet subscribers increased 3.36%, Frontier reported a 1.58% gain, and CenturyLink came in with a 1.13% gain. Windstream clearly lagged their peers with a decline of 5%.

The only measure where CenturyLink crushed the competition was in video additions. The company reported an 11.67% growth rate in video subscribers, which beat Frontier's 5% growth, and Verizon's 3.45% growth rate. Unfortunately for Windstream investors, their company finished last again with a loss of 4%.

So now what?
In the end, CenturyLink pays a lower yield than Frontier, and in two of the three “core” categories is under-performing. On the flip side, CenturyLink's balance sheet carries half of the relative debt, and their payout ratio is lower.

Investors who already own CenturyLink should likely keep an eye on the company's future earnings for continued deterioration in growth and margins. Continued pressure, coupled with improvements from Frontier, might be enough to make me pull the trigger and make a change. I'm staying put for now, but Frontier and their 9% yield looks awfully tempting.

Chad Henage owns shares of Verizon Communications and CenturyLink. 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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