The Dividend Cut No One Sees Coming

Just because it's not a problem right now doesn't mean it's not a problem at all. Investors in Frontier should avoid getting too comfortable.

Feb 24, 2014 at 5:00PM

One of the worst scenarios for an investor is when a stock in his portfolio has a dividend cut that no one expected. Typically, the stock price then falls because the dividend is cut and the yield is less attractive. To find balance, the stock must fall enough to make the yield attractive again. Existing investors not only have less potential dividend income, but a loss of capital as well. Frontier Communications (NASDAQ:FTR) stockholders have experienced this scenario and may think they don't have to worry, but there are signs the company's lower dividend may not be safe.

This is growing, and that's not a good sign
Growth is one of the key measures for investors in a company like Frontier. The company, along with rivals Windstream Holdings (NASDAQ:WIN) and CenturyLink (NYSE:CTL), is trying to find a way to stem the flow of voice line losses.

To build their other businesses, each of these companies has issued debt to raise money for expenses. On the surface, it looks like Frontier lands between its two peers with respect to relative debt. Frontier sports a debt-to-equity ratio of about 2, whereas CenturyLink is at 1.2 and Windstream is at a staggering 10.

However, the story isn't quite that simple. In the last three years, Frontier's debt-to-equity ratio has risen from approximately 1.5 to 2, and the company's long-term debt has risen about 2% in just the last four quarters. If Frontier continues down this path, the company's interest charges could become a problem.

Actually, now that you mention it
Frontier's rising debt load is already becoming a problem. One of the best ways to determine if a company is spending too much on debt is by comparing its interest expense to its operating income. After all, if the company spends a lot on interest expense, there won't be money left over for capital expenditures or dividends.

As a percentage of Frontier's operating income, the company is spending 66.5% even if we adjust for a current quarter pension expense. By comparison, Windstream is spending 62.6% of its operating income on interest expenses and CenturyLink is only spending 49%. Unless Frontier finds a way to grow its operating earnings, the company's growing debt will only make this situation worse.

One of these things is not like the others
One central issue that should worry Frontier investors is, the company is performing poorly relative to its peers when it comes to both residential and business revenue growth. In the current quarter, Frontier reported residential revenue was down about 5% and business revenue suffered an identical decline of 5%.

By comparison, Windstream and CenturyLink reported residential revenue declines of 3% and 1% respectively. An even bigger difference between the three came in the business revenue side of things, where Windstream and CenturyLink both reported a 1% increase in revenue.

Frontier simply can't afford to see a 5% annual decline in revenue from both residential and business customers and hope to turn this ship around.

A slow creep toward the inevitable
To be clear, Frontier's dividend isn't in trouble today, but if the company continues on its current path, the final result is clear. Look at how the company's core free cash flow (net income + depreciation-capex) payout ratio changes in the next year if the company doesn't make some major changes.


Net Income



Core FCF


Payout Ratio

*Q4 '13

$63 mil.

$280 mil.

$169 mil.

$174 mil.

$100 mil.


*Q1 '14

$61 mil.

$274 mil.

$169 mil.

$166 mil.

$100 mil.


*Q2 '14

$59.5 mil.

$269 mil.

$169 mil.

$160 mil.

$100 mil.


*Q3 '14

$58 mil.

$264 mil.

$169 mil.

$153 mil.

$100 mil.


(*10% annual net income decline-2% quarterly depreciation decline - stable capex of last 4 quarters-stable dividends)

Analysts expect a roughly 10% decline in EPS over the next few years. In addition, Frontier is seeing a 2% quarterly decline in its depreciation allowance. Even if we assume the company maintains its capital expenditures average over the last four quarters, the payout ratio rises every quarter.

Again, the dividend isn't in trouble today, but the above table suggests Frontier's dividend will get relatively less safe each quarter. If you want to monitor how the company is doing, consider adding FTR to your personalized Watchlist. You don't want to be caught unaware by a dividend cut that no one sees coming.

A tech stock that's really worth it
Opportunities to get wealthy from a single investment don't come around often, but they do exist, and our chief technology officer believes he's found one. In this free report, Jeremy Phillips shares the single company that he believes could transform not only your portfolio, but your entire life. To learn the identity of this stock for free and see why Jeremy is putting more than $100,000 of his own money into it, all you have to do is click here now.

Chad Henage owns shares of CenturyLink. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information

Compare Brokers