This High-Yield Stock Slashed Its Dividend in Half. It's an Even Better Buy Now.

CenturyLink's dividend cut may have surprised some investors, even though it shouldn't. Here's why investors should consider buying shares now.

Jason Hall
Jason Hall
Feb 24, 2019 at 9:15AM
Technology and Telecom

Many investors who bought shares of CenturyLink (NYSE:CTL) over the past couple of years did so exclusively for its stratospheric dividend. Investors who bought shares anytime since since mid-2017 have collected a yield that was regularly more than 10% of their purchase price, and sometimes well above. However, when the company reported earnings after the market closed on Feb. 13, many investors felt the unexpected tug of that high yield getting yanked out from under them. The dividend was being slashed from $0.54 per share each quarter to $0.25. 

By the time the dust settled after trading on Valentine's Day, CenturyLink shares were down 12%, and few investors were feeling very much love. 

Here's the rub: Management's move to lower the payout wasn't a forced cut. On a cash-flos basis, the company generates plenty of money to have continued the prior payout. Instead, executives made a painful decision to instead use more cash flow to strengthen the balance sheet, a move that investors should be applauding now. Furthermore, CenturyLink continues to represent a solid value, and frankly by lowering the payout, its margin of safety and ability to act opportunistically will become even greater. 

Check out the latest CenturyLink earnings call transcript.

Han with a needle preparing to pop a bubble that has a dollar sign inside.

CenturyLink burst investors' bubbles with a dividend cut, but the move should prove positive. Image source: Getty Images.

Making the difficult decision, not the forced hand

On one hand, it's reasonable to say that CenturyLink represented a bit of a dividend trap. With a double-digit yield that was pushing 15% at recent prices before the payout cut, there were warning signs that plenty of investors didn't believe the company could sustain its payout. However, the reality is, sometimes "could" and "should" get muddied. And in this case, I think the reality -- and management's decision to cut the payout -- is clearly a case of "should."

Case in point: Back in November, I argued that CenturyLink could indeed support the payout, and I noted that management continued to say that maintaining the then-current dividend was a priority. There's also solid evidence that the payout was plenty secured by its cash flows, even as its GAAP earnings payout ratio was well above 100% for years.

CTL Payout Ratio (TTM) Chart

CTL Payout Ratio (TTM) data by YCharts

Yet I also stressed that just because CenturyLink could maintain the payout -- and management was continually positive about doing such -- that was no guaranteed that it would. The road to dividend hell is paved with the words of executives who tell investors that maintaining a payout was a priority. As recently as November, on the third-quarter earnings call, CFO Neel Dev said, "We are pleased with the improvement in our payout ratio compared to last year and remain comfortable with the dividend."  

Nonetheless, investors should be relieved that management made a business-first decision with its capital allocation strategy, instead of doubling down on maintaining the payout. Investors will almost certainly be better served by an accelerated debt reduction plan. The reality is, since closing the Level 3 merger, interest expense and dividends paid have skyrocketed, even as free cash flows have also increased by an enormous amount:

CTL Total Interest Expense (TTM) Chart

CTL Total Interest Expense (TTM) data by YCharts

Why it's a better buy today

As a CenturyLink shareholder for nearly two years, I admit that things have been frustrating at times. But as a business-focused investor with a long-term horizon, every time I re-evaluate the company, I see this: 

CTL Price to Free Cash Flow (TTM) Chart

CTL Price to Free Cash Flow (TTM) data by YCharts

And when you factor in that the company has substantially lowered its expenses during the integration of Level 3 and its legacy business, while also generating massive amounts of extra free cash flows, you have a cash-cow business that's trading at a fraction of the price of other telecommunications companies. 

Yes, some of that discounted valuation makes sense. CenturyLink carries far more debt based on its size, and this leverage adds risk. Furthermore, the Level 3 merger has yet to result in sales growth, another factor that makes CenturyLink less deserving of the cash flows multiple its bigger peers command. 

But even with those risks and realities factored in, selling CenturyLink shares now would be a big mistake, in my view; to the contrary, it represents a bargain price, particularly considering management will now have an extra $1.3 billion per year in cash to improve the balance sheet and to invest in growth initiatives.

Lastly, the argument that CenturyLink's dividend isn't secure is now firmly in its past, even with its forward yield still almost 7.5% at recent prices. Management, frankly, has done a solid job improving the business over the past two years. Now it has an opportunity to change the narrative, and that alone could pay off for investors.