CenturyLink: Attractive Free Cash Flow Machine

The provider of local data and voice services might have limited growth prospects, but CenturyLink (NYSE: CTL  ) continues to innovate to maintain high levels of free cash flow, or FCF. The stock has recently surged following strong earnings and vindication that the large stock-buyback plan is paying off.

The company is shifting from legacy voice services to strategic products of high-speed Internet, Prism TV, and managed hosting services. The move isn't as much geared toward reinvigorating growth as stabilizing earnings and FCF potential. The other similar local telecom providers of Frontier Communications (NASDAQ: FTR  ) and Windstream Holdings (NASDAQ: WIN  ) sit in a similar situation, attempting to trade legacy revenue for new strategic products to maintain cash flow. Are investors starting to warm up to the sustainability of this model?

Strategic revenue growth
The ability to attract high-speed Internet customers and television customers has helped turn around a downtrend in the business. CenturyLink reported that first-quarter revenue increased compared to last year due to these strategic services. Revenue jumped 5.4% from the first quarter a year ago. Clearly, the strategic opportunities aren't driving massive growth. But stability is key with this investment offering a nearly 6% dividend yield and strong stock buybacks.

The primary gains came from adding approximately 66,000 high-speed Internet customers and 24,000 Prism TV customers. These customer gains helped push strategic consumer revenue up 8.8% and business segment revenue up 6.7%. The weakness continues to come from legacy voice and wholesale products. Wholesale revenue declined by nearly 5% and still accounts for $862 million of total revenue.

The numbers aren't as impressive at both Frontier and Windstream. Frontier saw revenue decline more than 4% from the first quarter of 2013. The local provider did add 37,200 broadband customers, but those gains didn't offset other customers lost, especially in residential voice, where the flow-through from losing 18,700 customers in the fourth quarter hit revenue this last quarter. 

Windstream did slightly better than Frontier, with revenue declining 2% from the same period a year ago. The company saw data services grow by 3%, but the division only generated $414 million in revenue, compared to the $1.5 billion total revenue.

Free-cash-flow stability

Possibly the most important story for CenturyLink is the continued ability to generate significant amounts of cash flow. The stock has maintained an incredibly high capital return level due to a refusal by the investment community to understand that the FCF levels were stable, allowing the company to continue paying the high dividends and affording the new stock buyback program.

For the first quarter, CenturyLink delivered an incredibly strong FCF of $860 million. The number was smaller than the first quarter of 2013, but it significantly exceeded the levels of the last three quarters. Windstream had the most impressive FCF quarter, producing $314 million, a surge of 27% over the amount from last year.

With CenturyLink shares surging over the last couple of months, the FCF yield has dropped, but the number still sits at 11.3%, according to the GAAP numbers in this chart. Using the non-GAAP provided by CenturyLink, the yield sits at a higher 13%, even after the large stock gains.

CTL Free Cash Flow Yield (TTM) Chart

CTL Free Cash Flow Yield (TTM) data by YCharts

The yields of both Frontier and Windstream are currently higher due to the revenue declines still occurring at those local providers. 

Bottom line
Investors have long feared that the dividends of the local telecom providers weren't sustainable due to the lack of wireless services. Those fears are starting to disappear with the shift to high-speed Internet and television offerings that can replace the legacy voice revenue that continues to decline.

CenturyLink isn't likely to see any meaningful growth anytime soon, yet the company remains very attractive at the current yield. New investors probably shouldn't rush into the stock until it cools off, but the stock offers compelling value with the substantial FCF yield.

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