Why Windstream Earnings Could Keep Waning

Windstream (WINMQ) will release its quarterly report on Thursday, and investors in the rural telecom company continue to face the pressures of a business in decline. Yet even as Windstream earnings appear poised to drop again this quarter, the bigger question investors are focusing on is whether the company can keep paying the impressive dividend it has given shareholders for years.

Windstream has been able to produce such impressive dividend yields because of the economics of its core business. With existing networks having been in place for decades, revenue from landlines and other legacy telecom services produces huge amounts of cash flow without demanding large capital investment. Yet as customers shift to newer technology, that cash flow inevitably declines, forcing the company to seek other paths to growth. Let's take an early look at what's been happening with Windstream over the past quarter and what we're likely to see in its report.

Stats on Windstream

Source: Yahoo! Finance.

Can Windstream earnings support its dividend?
Analysts in recent months have gotten more pessimistic about prospects for Windstream earnings, cutting June-quarter estimates by $0.02 per share and full-year 2013 projections by double that. The stock has produced modest gains nevertheless, with a jump of about 6% since early May.

The most remarkable thing about Windstream has been its dividend consistency. By contrast, CenturyLink (LUMN), which also has an extensive rural business, chose to cut its dividend by about 25% earlier this year in order to shore up its finances and provide more capital for growth initiatives. Frontier Communications (FTR) has suffered even greater struggles with its dividend, having made multiple cuts in recent years that have lopped a total of 60% from its payout as recently as 2010 as its core business has declined.

Windstream has faced that challenge by acknowledging the inevitable decline of parts of its business while seeking new growth from newer services. In its first-quarter results, the company saw a 2% rise in business-services revenue. Success in getting customers to buy broadband Internet service was even more pronounced, with gains of 5% from the year-ago quarter helping to offset falling revenues from landline and other legacy services. Windstream has also done a good job of keeping expenses down, which in turn has minimized the deterioration in earnings.

Interestingly, one consequence of earnings being lower than dividends is that Windstream's payouts aren't fully taxable. In July, Windstream said that almost two-thirds of its dividends in 2012 were reclassified as non-taxable return of capital rather than dividend income. That results in less tax from dividends, but it also reduces cost basis in shares, potentially adding to capital gains when investors sell. More importantly, the treatment, which Windstream expects to continue this year with 50% to 60% of income being non-taxable, reflects the outsized payout compared to GAAP earnings.

In the Windstream earnings report, watch for any signs that the company might change its long-held commitment to keep the dividend at current levels. With so many investors relying on the double-digit distribution yield, any cut could send investors fleeing. Frontier and CenturyLink saw similar investor exoduses when they made their cuts, so Windstream shareholders simply have to be on guard and try to anticipate an inability to raise sufficient cash to keep the payout at current levels.

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