3 Questions That Windstream Holdings’ Investors Need to Ask

Investors who own a stock with an almost-11% yield need to be hyper-focused on whether that yield is sustainable. Windstream Holdings (NASDAQ: WIN  ) has repeatedly said it is focused on keeping its dividend, and investors want to believe that. However, there are three questions investors should ask, but they may not like the answers.

How do you transform while sliding down a hill?
Windstream's management says that it wants to transform into an enterprise-focused company. That sounds good, but the company can't ignore the rest of its customers. In the local telecom industry, CenturyLink (NYSE: CTL  ) appears to be setting the standard. Of the three big local companies, only CenturyLink reported either flat or positive growth in both its residential and business divisions.

By comparison, Frontier Communications (NASDAQ: FTR  ) reported a decline of at least 3% in both residential and business revenue. Windstream reported a 4% decline in its residential business, but the larger business division reported flat revenue growth on a year-over-year basis.

On the surface, it would seem that Windstream did well to just maintain its business revenue, but behind the numbers there is a far more troubling trend. Windstream reported that total business customers declined by 5%. So, the first question facing Windstream is, how do you transform your business when your customers are leaving?

Though revenue growth was flat, customer losses means that Windstream raised prices to offset these lost customers. In an industry that is essentially a commodity business, raising prices while losing customers would seem to be a sure way to fail in the long-run.

These measures are rising and that's not a good thing
The second question investors need to ask is, how long can Windstream support its dividend while debt and interest are rising? On a relative basis, Windstream carries significantly more debt compared to its peers. CenturyLink shows the least relative leverage with a debt-to-equity ratio of just 1.2. By comparison, Frontier's debt-to-equity ratio sits at almost 2. Windstream takes debt to a whole new level with a debt-to-equity ratio of almost 12.

It would be one thing if Windstream carried more debt and was growing faster, but that isn't happening. Even more disturbing, Windstream's interest cost as a percentage of operating income is higher than its peers as well.

In a not surprising turn, CenturyLink carries lower interest as a percentage of operating income at 49%. While Frontier carries a bit higher interest percentage at 76%, Windstream again takes this to a whole new level at 85%. So, it's not hard to imagine that a company paying more in interest could run into trouble supporting its dividend.

Don't assume this is for real
Windstream investors are likely clinging to the fact that the company's core free cash flow payout ratio came in at less than 75%. For a company that spent the last year or so with a payout ratio over 100%, 75% must look much better.

However, the third question investors need to ask themselves is, what will happen to the company's payout ratio under normal capital expenditures? CenturyLink and Frontier already boast much lower payout ratios at 48% and 54%, respectively. The difference between Windstream and these two gets much larger when you consider the company's plans for capital expenditures in 2014.

Windstream has already said it expects to spend between $800 million-$850 million on capital expenditures this year. In plain English, Windstream spent 30%-40% less on capex in the current quarter than it intends to for the year. This means the company's roughly $200 million in core free cash flow wouldn't be the same under normal circumstances.

If nothing else, this is the big risk facing Windstream investors. Under the company's own planned capex for 2014, the payout ratio would rise well above 100%. For a company that carries relatively more debt than its peers, and is losing customers, spending this much on capex may be the final blow to the sustainability of its dividend.

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Read/Post Comments (5) | Recommend This Article (5)

Comments from our Foolish Readers

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  • Report this Comment On May 15, 2014, at 3:25 PM, oolioo wrote:

    I can think of many more than three questions to ask Motley Fool;

    One would be: How long have you been trashing WIN?

  • Report this Comment On May 15, 2014, at 3:56 PM, pnewman wrote:

    It seems to appear that your research on windstream and also other companies is not

    thorough enough, you fail to mention there expansion and building of data centers and the recent government contracts they have been awarded. Why not really report everything other then

    your one-sided opinon.

  • Report this Comment On May 15, 2014, at 8:12 PM, cww wrote:

    you may have waited a little too long to try to short sell win this time. that unbelieveable, unsustainable dividend rate is falling fast as the price of the stock recovers from you folks bashing.if the stock just recovers to the point that it was forecast to be a couple of years ago, then the yield will not be high at all. pick on another company for a while.win deserves a break.

  • Report this Comment On May 16, 2014, at 10:36 AM, InvestNRun wrote:

    After looking back at several telecom articles, it appears this guys a fan of Century Link on the local telecoms, and Verizon for the big boys with wireless.

    CTL is only just now peaking it's head back above it's 20% drop where they unexpectedly trounced their shareholders with a premature dividend cut. That's despite a 7% total stock buyback mentioned in another article of his. Verizon, well that's fine, lower than these "risky" dividend plays and a blue-chip.

    Windstream's the one of these local telecoms that didn't cut it's dividend once or more despite living on the edge a bit with payout ratios. It could in fact cut it's capex at nearly any point to reduce the payout ratios, but unlike some of the others it's investing HEAVILY in it's future so it can continue to be a fat dividend payer for the next 20 years. Having fiber in the ground puts up huge barriers to entry while costing low maintenance fees while charging customers premiums for data transport, just like the landline business has been doing for years despite landlines being nearly obsolete.

    I agree with other commenters, I'd peg this as a 10-10.50 stock without bashing from various popular investment websites. I'm not buying in the mid 9s. If it drops in the low 8s again because of enough bashing, maybe I'll be in the market like I was before, 11.5% dividend, I'll take it.

  • Report this Comment On May 18, 2014, at 10:09 PM, watersports2001 wrote:

    This stock has been as confusing as micron was last year before it went from 6ish to 23ish. I'm hoping the recent company buyings will this time lead me not to just a good dividend but some stock deals at some point as well.

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