You're Right to Love This Dividend Hero

Everybody loves Frontier Communications (NYSE: FTR  ) . The regional telecom's generous 9.7% dividend yield seems to make the stock a much more attractive place to park your savings than a boring old money market account. But we've seen big dividends go up in smoke before, and outsized yields can be a sign of impending doom for a company or for an entire industry. Is Frontier in a state of dividend overspend, or is your love for the company justified?

With second-quarter results fresh off the presses, it's time to take a look at Frontier's dividend health. Spoiler alert: It's good news.

Sales in the second quarter shrank by 3% year-over-year to $516 million as traditional landline customers continued to move over to cell phones. But the remaining customers tend to spend more, boosting the revenue per customer by 5% for residential accounts and 6% for the average business customer. So far, so blah.

But slower sales aren't necessarily a bad thing for Frontier, as earnings expanded from $0.09 per share to $0.11 per share. With fewer landline subscribers, there's less old-school equipment to maintain and no reason to install anymore of it. That leads to lower capital expenses (good for free cash flows) and depreciation charges (good for earnings). Free cash flows ballooned by 34% to $134 million, largely thanks to the lower depreciation costs.

So when you get down to brass tacks, Frontier's $78 million of dividend payments comes right out of free cash flows, which points to a sustainable dividend. Even better, the cash flows are growing.

Some dandy dividend payers aren't so lucky. For example, Terra Nitrogen (NYSE: TNH  ) sports an 11% yield but both shrinking cash flows and an outsized payout ratio. Penn West Energy (NYSE: PWE  ) pays out pretty much its entire free cash flow stream to investors year after year to achieve its 8.5% yield. Windstream (NYSE: WIN  ) has plenty of cash to spare for its 8.7% yield, but the flows are dwindling.

There's no growth left in any of these stocks, mired as they are in the thoroughly mature energy, landline telecom, and basic materials industries. Frontier is fighting that label and buying some growth, including the landline operations of Verizon (NYSE: VZ  ) across 14 states. That expensive transaction inspired Frontier to cut its annual dividend from $1 per share to $0.75 per share, which boots the company out of Dividend Aristocrats contention but still remains extremely generous. Before the cut, the yield stood around 12%.

You're buying Frontier for the dividends, and there's absolutely nothing wrong with that.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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  • Report this Comment On August 05, 2010, at 3:21 AM, JFarina1976 wrote:

    Although I own FTR shares myself, P/B, Payout Ratio and Debt/Equity ratios are very high.

    But even after the dividend cut, the yield is still very attractive...

    Top 250 list of the highest dividend yielding stocks: http://www.dividend.co.nr

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