What's happening

Shares of regional telecom giant CenturyLink Inc. (LUMN -1.51%) opened trading on Nov. 9 down more than 12% following release of the company's third-quarter earnings report after market close on the 8th. As of 11:50 a.m. EST, its share price has recovered some but is still down more than 9% in very heavy trading. 

What's a bit surprising about the big sell-off is that CenturyLink actually came in a bit better than Wall Street analysts were expecting. The company reported earnings of $0.30 per share, while the consensus expectation was $0.27 per share on an adjusted basis

Man looks at chart line that's gone down.

Image source: Getty Images.

So what

CenturyLink also reported solid cash flows in the quarter: operating cash flow of $1.79 billion, up 8% year over year, and free cash flow of $1.1 billion, nearly double last year's amount. The company also raised its full-year forecast for free cash flow by $400 million, adding even more to its growing cushion to support its dividend and pay down debt from its recent Level 3 Communications acquisition. 

But while those items look great on the surface, there are some things to be if not concerned about then at least aware of. The reason the company's free cash flow is set to shoot up so much is due to a substantial reduction in planned capital expenditures before the end of the year. 

This year's capex budget had been for approximately 16% of revenue, but management announced full-year guidance between $3.15 billion and $3.25 billion, which works out to about 13% of expected full-year revenue. That's a substantial reduction that probably has some investors concerned the company is deferring needed spending to artificially inflate free cash generation this year. 

Furthermore, CenturyLink continued to see revenues decline, and unfortunately, the sales weakness extended beyond its legacy copper-line voice and broadband services and included every segment of its business. While it was expected that its residential landline and even business voice sales would continue to fall, the Level 3 merger was expected to deliver steady growth across its more advanced -- and more profitable -- services and enterprise-scale offerings.

That didn't prove to be the case last quarter, with a revenue decline in every business unit and service type. 

On the earnings call, management made a solid case to explain its reasoning for the reduction in capital expenditures. Recently appointed CFO Neel Dev said the following: 

In addition, we put in place a capital governance process comprised of senior leaders of the company to ensure all investments are in line with business and financial objectives. The financial rigor and discipline led to several decisions to redirect investments. One example is our decision to minimize investment in our copper based plant for the consumer business. However, we are ramping up investments in our fiber footprint for consumer to complement our micro targeting strategy. These changes in capital investment strategy led to some air pockets in spending as some projects ramp down and others ramp up. Next, our supply chain and network planning teams have done an excellent job in recovering and redeploying equipment and capacity, leading to capital spending avoidance and a significant non-recurring benefit for 2018.

In other words, this isn't a short-term cash-preservation move but part of a bigger, more thought-out strategy to deliver better returns through more disciplined capital allocation. Whether it delivers over the long term will remain to be seen, but it's hard to argue with the decision to reduce investments in its copper-line business, particularly if there are other areas that can generate a better return. 

As to the revenue decline across all segments, that's not something that should be ignored, and investors should continue to watch for a reversal. A single bad quarter doesn't make a trend, and management did point out actions it is taking to identify unprofitable contracts -- of which there was at least one big one this past quarter -- and that could impact its short-term revenues, though at the benefit of its long-term profits. 

Now what

Despite the weak spots in its earnings report, I don't think the thesis -- at least my thesis -- has really changed. From my view, today's sell-off has created an excellent opportunity to buy this misunderstood and overlooked high-yield dividend play at an even better value. 

After this sell-off, shares trade for six times free cash flow and only three times operating cash flows, and the dividend yield is well over 10% (and well supported by those cash flows). Now looks like an excellent time to load up on CenturyLink while it's on sale.