Is Windstream Holdings, Inc's High-Yield Dividend Safe?

Windstream offers a nearly 10% dividend yield, but there are red flags investors should be aware of before jumping in.

Jul 15, 2014 at 11:15AM

Telecom investors are first and foremost concerned about the safety of their companies' dividend payments. Those dividends are likely why most investors buy the stocks of telecommunications companies like AT&T (NYSE:T) in the first place, as telecoms typically offer dividends that are much higher than most other companies. AT&T offers a strong 5.2% payout, for example, and there are others in the sector that do even better.

One such company is Windstream Holdings (NASDAQ:WIN), which pays a 9.9% yield. That's a huge yield that probably entices many investors. Sometimes, however, dividends can be too good to be true.

For income investors, the sustainability of a company's payout is just as important as the yield itself. An extremely high-yielding company can only pay its dividend without sufficient free cash flow for so long.

To that end, let's dig deeper into Windstream's financials to determine whether its dividend is safe.

Windstream flashing warning signals
As previously mentioned, Windstream's dividend is huge, even for a telecommunications company. Even peers like AT&T only offer about half of the yield that Windstream provides. Unfortunately, its core metrics like free cash flow don't inspire much confidence. Here's how Windstream's key financials stack up against AT&T.

 

2013 Free Cash Flow

Dividend Payments

Free Cash Flow Payout Ratio

Windstream

$678 million

$593 million

88%

AT&T

$13.8 billion

$9.7 billion

70%

Source: Fiscal Year 2013 Financial Statements

As you can see, Windstream's financial condition is far from ideal. Most investors use free cash flow to gauge the underlying health of the company, and it's definitely a useful tool. Free cash flow is an effective way to analyze a business because it strips away non-cash items. Based on this, investors should be skeptical about Windstream's position since it distributes almost all of its free cash flow.

Even more disturbing is that underneath the surface, there are additional reasons to lose confidence in Windstream's free cash flow.

Why Windstream may be in more distress than meets the eye
Free cash flow adds back non-cash items like depreciation. The rationale is that companies shouldn't be penalized for taking high-depreciation expenses against earnings, since depreciation isn't truly a cash outflow.

That doesn't mean companies should get credit for lots of depreciation, either. In Windstream's case, its free cash flow number looks inflated because it incurred $1.3 billion in depreciation expenses last year. That gets added back to net income to determine free cash flow. Its depreciation was far higher than its net income, which stood at just $241 million last year.

By contrast, AT&T's depreciation and net income are about equal. AT&T isn't reliant on adding back huge levels of depreciation to produce a satisfactory level of free cash flow.

Telecommunications companies like Windstream hold considerable fixed assets, so it's reasonable to expect a lot of depreciation. A company whose free cash flow is made up almost entirely of adding back non-cash items is a warning sign, however.

In addition, Windstream is struggling to keep subscribers. It's still reliant on traditional voice lines, which are rapidly going the way of the buggy whip in the smartphone era. Windstream's voice lines in operation fell 6% last quarter.

It's also losing digital TV and high-speed Internet customers as well. Total customer connections dropped nearly 5% last quarter. Moreover, Windstream's bread-and-butter are small businesses. But small businesses are rapidly adopting new technology, which is causing customers to cut Windtream's services. To that end, Windstream's business customers fell 7.5% last quarter.

As customers cut the chord with cable and wireline connections and small businesses embrace new technologies, Windstream looks increasingly vulnerable going forward. Its weakness is even more pronounced if the company keeps losing federal subsidies. To that end, revenue from the federal Universal Service Fund fell 9% last year, much more than the 2% drop recorded the year before. If this pattern continues, it will severely impact Windstream's revenue and further compress cash flow since the company will receive fewer subsidies to expand its network.

All these reasons explain the vastly different dividend track records between Windstream and AT&T.

Dividend histories tell the truth
AT&T has increased its dividend for 30 years in a row. Meanwhile, Windstream hasn't increased its payout since 2006. Over the past five years, AT&T has increased its dividend by about 2% annually. This might not sound like much, but it at least provides greater protection of purchasing power against inflation than a static payout like Windstream's.

It's unlikely that Windstream will be able to raise its dividend any time soon because its financial condition is weaker than it seems. In addition to free cash flow being boosted mostly by huge depreciation, the company also has $8.7 billion in long-term debt on the balance sheet to deal with. This will be problematic once interest rates start to rise.

As a result, while a dividend cut isn't necessarily on the horizon for Windstream, there are better alternatives within the telecom space for investors to choose from.

These dividends may be safe for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Bob Ciura has no position in any stocks mentioned. 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.

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