Should You Buy CenturyLink Before the Price Recovers?

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

CenturyLink (NYSE: CTL) is one of the classic dividend stocks. Bonds rates are low, especially those on U.S. Treasuries, and investors who want income from their investments have turned heavily toward stocks. The dividend yield on the S&P 500 was actually higher than the yield on Treasuries earlier this year (CNBC.com), and even now they are quite close. This has clearly benefited companies like CenturyLink, as yield-starved investors go chasing after its high dividend.

For all of this good news, however, CenturyLink's stock has taken a severe beating over the course of this year. Thankfully, this is easily explainable. Earlier this year, the company substantially reduced its quarterly dividend from $0.725 per share to $0.540 per share (CenturyLink). It also announced a $2 billion buyback program over the next two years, but many investors doubted that it would actually fulfill this promise. This caused a major sell-off in the stock with the price falling almost $10 (1/3 of the share price) in one day.  

That sell-off certainly did not help the investors who owned the stock, but it does have one significant upside for those considering entering the market. Before the dividend cut, the yield on the stock was about 6%, but now that both the stock price and the dividend have fallen the yield is actually 6.1% (Yahoo! Finance). In other words, if the stock was a good buy before the cut in the dividend, as many people thought it was, it is again. 

Will CenturyLink cut its dividend again?

The prominent potential downside to CenturyLink's stock is the potential that it will cut its dividend again, causing another major sell-off like the one in February. Thankfully, If one looks at its recent financial statements that fate does not seem entirely likely. The company is implementing its share buyback plan aggressively and has already purchased $682 million of its stock, which is remarkable because this amount is larger than the $460 million that it saved in dividend payments (Seeking Alpha).

The problem that CenturyLink is facing revenue-wise (and hence the reason that it cuts its dividend) is the decline in wired telecommunications. The company saw its revenue in what it calls Legacy revenue fall by 8.7% in the consumer sector and 4.6% in the business sector. Its strategic revenues increased by 4.1% year-over-year, however. Furthermore, the company's revenue in the first quarter was at the top of its guidance range, and it slightly raised its guidance on operating cash flow and adjusted diluted earnings-per-share for the year as a whole (CenturyLink). Thus, it should be able to accomplish its goal of revenue stability in 2014 (CenturyLink).

In other words, the company should be able to keep paying its dividend and continue its stock buyback program. It may not able to keep the yield the same if its stock price rises substantially, but that is a good problem for an investor to have. In other words, it may be wise to buy CenturyLink before its price goes up. 

Comparable companies

 CenturyLink VerizonAT&T
P/E 25.50 126.92 28.07
Dividend Yield 6.10% 4.10% 5.10%

CenturyLink is the third-largest telecommunications company in the U.S., and so it makes sense to compare it to the two largest. Both of its major competitors pay high levels of dividends, though not quite as high as CenturyLink's. Furthermore, all three companies have a part of their business that can grow long-term, but another part that is shrinking.

AT&T (NYSE: T) might be worth considering for the same reasons as CenturyLink. It gives out a decent dividend yield (5.10%), but because of that it is relatively expensive with a price-to-earnings ratio of 28.07; this is especially true considering its revenue only increased 2.4% between 2011 and 2012. On the plus side, its earnings per share did increase by 8.5% (AT&T).

Furthermore, with the rise of the prepaid phone, it will potentially suffer serious revenue losses even in its major profit center -- mobile phones. If we compare this with CenturyLink, the biggest attraction in both stocks is the dividend, but CenturyLink's is higher. They both have a legacy business that they are both trying to get out of and are in that sense similar. If many analysts are right and prepaid phone usage rises significantly over the next couple of years, however, then AT&T's core business will take a major hit. CenturyLink is not facing a similar problem. It should be able to grow its main business quite a bit over the next couple of years.

This problem is even larger for Verizon (NYSE: VZ) because it is barely competing in the prepaid space at all. Unlike AT&T, Verizon's prepaid phone service is priced so expensively relative to the competition that it would have to make a major switch in its business model to gain any significant market share. This is especially a problem since the company doesn't have first-mover advantage. Furthermore, its price-to-earnings ratio (126.92) is sky high, especially considering that Verizon is a blue chip. Even if prepaid phones do not cause problems for Verizon, it will likely not be able to achieve the earnings growth necessary to justify its high valuation. Currently, Verizon's revenue is growing faster than AT&T's at 4.5%, but still not at a level nearly high enough to justify its valuation.

Conclusion

To wrap things up, CenturyLink is currently the cheapest of the three main telecommunication companies. Furthermore, the company has solid financials and is successfully managing its transition from being a phone business to a broadband one. Its future growth may not be market-beating, but it is not likely to fall behind Verizon and AT&T because they are facing significant headwinds in the form of the rise of prepaid phones. So if you're looking for a high-yielding stock, consider buying CenturyLink before the price recovers.

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Paul Sangrey 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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