What happened

In response to the company's disappointing first-quarter earnings profits and announcement of a substantial dividend cut, shares of Frontier Communications (NASDAQ:FTR) fell by as much as 15% in early-morning trading on Wednesday before settling down.

So what

Here's a review of the headline numbers from the company's first quarter:

  • Revenue surged 74% year over year to $2.356 billion. The massive jump is attributable to the acquisition of certain wireline assets from Verizon Communications. This figure came in slightly ahead of Wall Street's estimate.
  • Net loss attributable to common shareholders was $129 million, or $0.11 per share.  This was far worse than the $0.05 loss that market watchers had projected.
  • Adjusted free cash flow was $175 million.
  • Customer monthly churn was 2.37%, up sharply from the 2.08% recorded last quarter.

Financial results aside, there's no doubt that the biggest driver of today's price action was the company's decision to substantially cut its dividend. The new quarterly payout is $0.04 per share, a 62% cut from its prior quarterly payout of $0.105 per share.

scissors cutting bill in half

Image source: Getty Images.

On the dividend cut, CEO Dan McCarthy said: 

Our Board regularly reviews the Company's long-term capital allocation strategy, and it has determined to reduce the dividend at this time to provide additional financial flexibility, while still returning a meaningful cash dividend to shareholders. As we continue to execute on our strategy to deliver on the full potential of our strong assets and generate additional cash flow, we will optimize our capital allocation to ensure we strike a balance between investing in the business, paying down debt and returning capital to shareholders.

Now what

While Frontier's decision to cut the dividend is likely to drive several income investors away from its stock, there's little doubt that it was the right move for the long-term health of the business. The reduction is anticipated to free up about $300 million of additional cash this year, with that number expected to jump to $400 million annually in the second half of 2018. The company stated that it will use that extra cash to pay down its substantial debt load, which totaled more than $17.5 billion at quarter's end. Frontier believes that the extra debt payments will allow it to drop its leverage ratio to 4.0 times by the end of 2019 and to 3.5 times by the end of 2021.

Frontier's drop today should be a reminder to all income investors that stocks with extraordinarily high yields can often be quite dangerous to own. That's why it is important to put any dividend stock to the test before buying it. Doing so will go a long way toward avoiding the carnage that Frontier's shareholders are experiencing today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.