Buying into regional telcos has been a gutsy undertaking for typically risk-averse income investors. Yield chasers have been smacked around by imploding payouts. But one of the niche's less-troubled players is starting to stand out from the problematic pack. Shares of CenturyLink (LUMN 6.75%) hit 11-month highs last week after the company posted encouraging financial results and boosted its guidance -- and those levels will stand as 52-week highs later this week once we lap last year's mid-August peak.
Last week's 13% pop naturally pushed the yield lower for the independent local exchange carrier. The quarterly distributions have remained constant at $0.54 a share since 2013, so with the stock at its highest point in nearly a year, that means that the yield is also at its lowest point in the same time frame.
However, regional telcos have a history of slashing their dividends or nixing them entirely. So CenturyLink kicking off this week with a seemingly sustainable 10.1% yield has to feel a lot better than when its yield peaked at 16.4% late last year (when the stock bottomed out with concerns about the dividend's viability).
Image source: CenturyLink Inc.
CenturyLink isn't just phoning it in
Last week's second-quarter report wasn't perfect. Revenue declined 2% to hit $5.902 billion with slight dips in both its business and consumer segments. Analysts were holding out for $5.92 billion on the top line. The news gets a lot better as we work our way to the other end of the income statement. Net income more than quadrupled to $292 million, or $0.27 a share. Back out a one-time benefit of after-tax integration-related expenses and special items, and CenturyLink's profit still clocks in at an impressive $0.26 a share. Wall Street was settling for net income of $0.25.
CenturyLink has now landed ahead of analyst profit targets in back-to-back quarters, a welcome change from the countless misses it racked up in earlier periods. Its margins have dramatically improved, largely the result of realized synergies following the $25 billion acquisition for Level 3 Communications it completed last year. The chunky buyout follows earlier deals for Embarq, Qwest, and Tier 3 to provide scalable opportunities on both the consumer and enterprise side of the telecommunications universe. Business customers now account for the lion's share of its revenue.
Improving margins as CenturyLink makes headway on its goal to land $850 million in annual operational synergies in the next three years is giving the once out-of-favor investment new life. CenturyLink is boosting its guidance in the areas where income investors need it most. It now sees $9 billion to $9.15 billion in adjusted EBITDA and $3.6 billion to $3.8 billion in free cash flow this year, up from $8.75 billion to $8.95 billion and $3.15 billion to $3.35 billion, respectively.
It's not ideal to see revenue taking baby steps back, but as long as the bottom line keeps improving, the healthy dividend checks should continue. CEO Jeff Storey said earlier this year that he's committed to living up to the stock's beefy distributions, something that's easier said than done for a company that has had a payout ratio north of 100% every year since 2011. However, with CenturyLink now expecting to generate more free cash flow this year than it did at the time of Storey's dividend-supporting comments, that's a dark cloud that seems to be passing -- for now.
CenturyLink still has a lot of work to do. But for now, it's doing right by more than just its public shareholders, having contributed $500 million to its pension plan this year. Sooner or later, the company will have to find a way to generate organic growth -- you can't squeeze the synergy sponge forever. However, the chances of CenturyLink reducing or even eliminating its dividend, as some of its smaller rivals have, is seeming less likely in the near term.
