Will Frontier's Earnings Uproot the Dividend Tree?

Will Frontier Communications (Nasdaq: FTR  ) upcoming earnings statement lay an egg, or will it produce some hope for investors in this rural telecom? Analysts estimate that earnings per share will come in at $0.06. The last two quarters produced an EPS number coming in below estimates, according to Bloomberg Businessweek.

Check out the chart below to see why the many loyal investors who have relied on Frontier's high-flying dividend yield will be paying close attention to the release.

Source: YCharts.

Source: YCharts.


Is the dividend sustainable?
The first nine months of 2011 produced a free cash flow of $573.4 million. The dividend payout during that period was $559.8 million, making the free-cash-flow-to-dividend-payout ratio a razor thin 97.6%. The first nine months of 2010 produced a much-more-reasonable payout ratio of a 62%. With revenues for the quarter expected to drop 6.6% from the same quarter last year -- and last quarter's revenue decline was 8% over the previous year's equivalent time frame -- it's hard to see how Frontier will be able to continue with a dividend yielding over 18%.

Why the revenue fell
Frontier tripled its subscriber base when it bought a bunch of cast-off rural phone lines from Verizon (NYSE: VZ  ) for $8.5 billion in 2010. Much of that 8% revenue decline in the third quarter was caused by customer attrition from those former Verizon properties. Even worse, net income fell 33% during that quarter in spite of Frontier cutting back operating expenses by 3.5%.

Frontier has not helped itself in the customer relations department. During the year, it raised FiOS (part of its Verizon purchase) prices by 46% in Indiana, almost forcing customers to change to Comcast which was offering much cheaper prices. It also jacked up FiOS installation prices in Oregon from $79 to $500, forced DSL customers to rent their modems, and was sued for allegedly collecting illegal fees.

Frontier's strategy may have been to push its customers to maintain more-expensive FiOS service to satellite services provided by DirecTV and DISH Network (Nasdaq: DISH  ) , companies which Frontier has associations with.

We'll have to wait and see from the earnings statement whether Frontiers three-year wireless reselling agreement with AT&T (NYSE: T  ) has provided a needed revenues lift. Rival carrier CenturyLink (Nasdaq: CTL  ) signed a similar agreement with Verizon.

Lucky charms, anyone?
There will be a lot of crossed fingers as investors wait for Frontier's earnings secrets to be revealed. I'm afraid a rabbit's foot, four-leaf clover, and an eye of newt would not be unreasonable items to have on hand as one waits.

Frontier offers one of the highest yields around, which offered some solace for the tumble in price it took this year. But if trading away some dividend yield for less volatility is more in line with your investing style, then check out this report from Motley Fool analysts: "Secure Your Future With 11 Rock-Solid Dividend Stocks." It's free!

Fool contributor Dan Radovsky owns shares of AT&T and Frontier. 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.

Fool contributor Dan Radovsky owns shares of AT&T and Frontier. 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.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 15, 2012, at 10:39 PM, valueinvesting12 wrote:

    To calculate free cash flow, you need to subtract maintenance capex from operating cash flows. The mistake you're making is to subtract ALL capex (maintenance and expansion) from the operating cash flows. Frontier's CEO has said that maintenance capex is 10%-11% of revenues. Once you calculate free cash flow correctly, you see that the dividend is covered with ample cushioning.

    Don't feel bad though... lots of people are making that mistake with Frontier. It's why the stock is so cheap.

  • Report this Comment On February 16, 2012, at 7:14 AM, johnnyque354 wrote:

    Verizon sold Frontier a network that was far beyond it's engineered lifespan by 35 years. This fact, coupled with the knowledge that Verizon's most talented personnel and finances were transferred out of these areas long before Frontier's ill fated purchase. The old POTS Network that Verizon sold to Frontier, were never meant for broadband, a broadband network of 2.8 megs at the best. Frontiers recent move from FIOS is rooted in the realization that they do not have the technical personnel or departments with the knowledge on how to get this technology to even work. In addition, the CEO's purchase of Frontier's stock was nothing more than her attempt to get the stock to raise. Keep in mind, it was this same CEO who sought out the purchase of these facilities from Verizon and she got spanked. Take away the millions in stimulus funds and what do you have? Be careful, it really is not worth it. Buy Verizon.

  • Report this Comment On February 16, 2012, at 7:23 AM, XMFDRadovsky wrote:

    valueinvesting12,

    Capital expenditures are capital expenditures, no matter what a company calls them. To split it into two different categories to make the dividend payout ratio less onerous than it otherwise would look, is disingenuous at best -- something less polite, at worst.

    If something is a legitimate ongoing operating expense, it should be labelled as such.

    So, no, I don't think I made a mistake by taking what the company says is a capital expense (whether for expansion or "maintenance") and using that to come up with my free cash flow number.

    If any CPAs out there think I am wrong about this, please let me know.

    Cheers,

    Dan

  • Report this Comment On February 16, 2012, at 10:46 PM, Merlin186 wrote:

    Well it looks like the dividend argument has come to an end. The new quarterly dividend will be $.10 per share, or just under 9% at today's closing price of $4.46. Now let's see how the company moves forward from there.

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