Better Buy: Frontier Communications Corp. vs. T-Mobile US Inc.

Just about everyone owns a phone. That's not likely to change anytime soon, regardless of economic circumstances. That's what makes investing in telecom companies so appealing, especially for retirees seeking relative safety and income in the form of dividends.

On the face of it, Frontier Communications (FTR) would appear to be a better buy for such people than T-Mobile (TMUS 0.02%). The former offers a very enticing 8.6% dividend yield, versus absolutely nothing from T-Mobile.

But dig a little deeper and we see that the picture isn't so clear. Here's what I mean:

Financial fortitude

It's no secret that telecoms have enormous up-front costs. It isn't cheap to lay the requisite wires and build the necessary towers to provide seamless coverage for customers. Frontier and T-Mobile are no different, with both sporting huge debt levels relative to their cash position.

Data source: Yahoo! Finance. FCF=Free Cash Flow. Both net income and FCF are based on trailing 12 months.

There is a clear distinction as to who has a stronger balance sheet: T-Mobile. By producing $873 million in FCF over the past year, the company has more than enough to meet its debt obligations.

Ironically, T-Mobile is in a much better position to offer a dividend than Frontier. Over the past 12 months, Frontier has brought in only $48 million in FCF, but used almost $800 million to pay out its dividend. Clearly, that's not sustainable.

Management claims that acquiring AT&T's (T -1.21%) Connecticut business and Verizon's (VZ -4.67%) California, Florida, and Texas operations will help improve FCF over the long run. But for now, such moves make Frontier far more fragile than T-Mobile.

Winner: T-Mobile.

Valuation

Because Frontier has actually operated at a loss over the past 12 months, it can be difficult to gauge how expensive it is relative to T-Mobile. But if we consider a number of different valuation metrics, a clearer picture comes into view.

Data sources: Yahoo! Finance, E*Trade. P/E calculated using non-GAAP earnings.

There's no question that T-Mobile represents the better value at today's prices. The company is cheaper on every single metric. While Frontier's current stock price -- which is 37% below its 2015 highs -- could look cheap in hindsight, that will only be the case if the company can prove that its acquisitions were timely and produced much more FCF than Frontier has been able to churn out over the past year.

Winner. T-Mobile.

Sustainable competitive advantage

This is the most important of the three lenses through which an investor should view any company. If the business you are buying shares in doesn't have a distinct competitive advantage, competition will eventually erode the company -- and your investment dollars.

Frontier used to be focused primarily on landline telephony and Internet in rural areas. However, as mentioned above, it recently purchased major operations in Connecticut, California, Texas, and Florida. The purchase from AT&T got off to a very rocky start, but results from the Verizon acquisition have been much more promising. Investments in customer service must be successful, as it could be one of the key factors that sets Frontier apart from the competition.

T-Mobile, on the other hand, relies primarily on its growing market share as its competitive advantage. The company has added over 1 million customers per quarter over the last seven quarters. That growth has come primarily at the expense of AT&T and Verizon. For every customer T-Mobile loses to these rivals, it gains 1.5. That's made possible by enticing users with unlimited data and music streaming.

Nonetheless, it's clear that if T-Mobile continues to win customers with this strategy, AT&T and Verizon may be forced to offer equally enticing promotions.

Winner: Tie.

In the end, the overall winner here is clear: T-Mobile. The company has shown impressive growth and has a healthy balance sheet. Frontier, on the other hand, is in the middle of a turnaround and finds itself very vulnerable to the effects of a blip in business.