Avoid these Two Giants, but Buy Wal-Mart

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

With interest rates near zero, investors have been desperately seeking strong yields. Investors are moving toward high-yielding stocks as an alternative to bonds, but they need to do in-depth research before initiating any position in any stocks. The recent plunge in the economy as well as new emerging markets have forced many companies to cut or sustain similar dividends. These cuts in dividends mean that companies are not able to sustain their profitability momentum over a long period. In this piece, I pick two companies that I believe are not solid investments for dividend investors. I also pick one company from the Consumer Cyclical sector for safe income.

CenturyLink dividend profile

CenturyLink (NYSE: CTL) is recognized as a leader in the network services market. After sustaining a quarterly dividend of $0.724 for the past 12 quarters, the company announced a cut in its dividends. At present, CenturyLink offers a quarterly dividend of $0.54 cents per share.

Why the dividends are not safe

CenturyLink’s top line growth has been quite stagnant over the past few quarters, though it has been able to achieve solid broadband and Prism TV customer growth in the first quarter. Its first quarter revenue of $4.51 billion represents a decrease of $0.10 billion over the same quarter a year ago. To cope with stagnant top line growth, CenturyLink is creating and capitalizing on organic growth opportunities. Additionally, the company is looking to enhance its margins. They are implementing an organizational realignment in order to strengthen their go-to market strategy and service delivery process.

The company’s financial situation is not good enough for dividend investors at present. After a dividend cut, it is paying more in dividends over its earnings. In the trailing twelve months, its payout ratio based on dividends stands at 193.1%. At the end of the recent quarter, its net earnings stood at $298 million, while it paid $341 million in dividends. To top things off, the company has a high debt-to-equity ratio of 1.0 relative to the industry average of 0.8. Another red flag is its cash flows, which also show decreasing trends.

Windstream Corp dividend profile

Windstream (NASDAQ: WIN) offers advanced communications and technology solutions – including managed services and cloud computing – to businesses nationwide. It has sustained its quarterly dividend of $0.25 cents/share over the past four years.

Why the dividends are not safe

Over the last few years, Windstream has pursued an aggressive acquisition strategy, allowing the company to broaden the types of services it provides. Windstream has experienced a decline in the fixed-line phone business, however. As a result, its revenue growth is decreasing quarter-over-quarter. Recently, it announced its first quarter results with total revenue of $1.5 billion, a decrease of 2%.

Along with decreasing revenue, its earnings are also decreasing. Still, the company has sustained its quarterly dividends. As a result, its payout ratio based on dividends is increasing year-over-year. In the trailing twelve months, its payout ratio stands at 364%. This means that Windstream’s earnings are not providing enough cover to its dividend payments.

Furthermore, its free cash flows do not provide cover to its dividend payments either. In this situation, I feel it is difficult for the company to sustain its dividends over the next few quarters until they have enhanced their revenue base as well as margins.

Wal-Mart dividend profile

Wal-Mart (NYSE: WMT) operates in three business segments: Walmart International, Walmart U.S, and Sam's Club. Over the years, Wal-Mart has consistently increased its dividends. Over the past five years, it has been able to enlarge its dividends by 97.89%. At present, the company offers a quarterly dividend of $0.47 cents per share.

How the dividends are safe

Wal-Mart is one of the best businesses in the U. S., and by most measurements it has been a great long-term investment. Below are a few key metrics that demonstrate its long term profitability:

  • Debt/Equity ratio 0.5
  • Earnings-per-Share for the past five years 9.69%
  • Earnings-per-Share for the next five years 9.29%
  • Payout ratio 31.7

Wal-Mart has shown solid financial performance over the years. Its top line growth is solid. It has been able to enlarge revenue on average by 4.8% in the past three years while the industry average stands at -0.7. Additionally, it has solid margins on sales. At the end of the recent quarter when sales increased by only 1%, it was still able to enlarge its earnings-per-share by 4.6%.

Along with solid profitability, its earnings provide full cover for its dividends. In the trailing twelve months its payout ratio stands at 31.7%, providing a lot of room to increase its dividends. Furthermore, its free cash flows are also enough to pay dividends. At the end of the recent quarter, its free cash flows stood at $12.67 billion while dividend payments accounted for only $5.3 billion. On the negative side, it has increasing competition from Amazon and Costco. Both companies have lower fixed asset bases and operate at much lower profit margins.

Final notes

CenturyLink is experiencing difficulties in its top line growth. The company is making smart moves and investing heavily in growth opportunities, however. All the same, I think the company’s financial situation is not healthy for dividend investors at the moment. Windstream has sustained consistent dividends over the past four years, but at the same time its profitability is decreasing which has pushed its payout ratio up to 360% at present. I think the company will have to enhance its revenue base and margins to sustain its dividends. In the case of Wal-Mart, it is a solid investment for the long haul.

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siraj sarwar 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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